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Guarding Your Wealth for Senior Citizens
Do You Owe Taxes On That Gift?
By Jeffrey D. Voudrie, CFP
July 14, 2006 - Many readers of this column take me up on my offer
for free financial advice. ‘Mr. K’ from Michigan, like many, wondered
about taxes owed on his mother’s house. Chances are you will deal with
the same issues.
He writes, “I have a question about my mom's home
that I inherited. Before my mom died she put her real estate into joint
ownership between her and my sister. It was supposed to help make
settling her estate easier.
Before mom passed away, my sister died.
After my sister died, mom placed the real estate jointly between herself
and me. Mom passed away over a year ago and I am now contemplating the
sale of her house. After mom's death I had the home transferred to my
and my wife’s names.
What are my capital gains liabilities on the sale
of the house? Do I pay capital gains on the whole sale, half the sale,
or none of the sale?”
Mr. K’s question provides an excellent opportunity
to clarify the confusing matter of gifting and inheritance. Few people
are aware of the tax implications and needlessly end up creating a tax
headache for themselves and their loved ones.
Let’s explain what an inheritance is and how it
differs from a gift. An inheritance is money, property, or another asset
of value that is transferred after death. A gift occurs when money,
property or other assets are transferred before death. An inheritance
and a gift are handled very differently from a tax standpoint.
Each of us can give gifts up to $12,000 per year to
any person we want without any Federal tax implications. (There may be
some state gift tax implications so check with an accountant.)
Inheritances aren’t subject to Federal Estate Tax
unless the estate’s value is over a certain amount, which as of January
1st, 2006 is two million dollars.
Because all assets owned by the
deceased are included in the estate’s valuation (i.e. retirement
accounts, annuities, life insurance, etc.), reaching that two million
dollar limit is easier than you think.
Even if there is no gift or estate tax when the
assets are transferred, there can be capital gain taxes when the assets
are sold. The trick is determining the asset’s original value, or cost
basis, and that depends on whether the asset was a gift or an
inheritance.
When you receive a gift, you also receive the cost
basis the person giving the gift had. So, if a parent paid $10,000 for a
home and it was worth $100,000 when it was gifted to the child, the
child now has a
cost basis of $10,000. If the house is sold 5 years
later for $125,000, the child will owe taxes on a gain of $115,000.
If the house was instead inherited by the child,
the cost basis is the value of the house at the time of inheritance,
which in our example would be $100,000.
So when the house is sold 5 years later for
$125,000, the child only owes taxes on the gain of $25,000. In tax
parlance, the house received a step-up in basis when transferred after
death. It doesn’t if transferred prior to death.
Let’s apply this to Mr. K’s situation. When Mom
added Sister’s name to the deed, it was a gift to the sister of 50% of
the value of the home and sister’s cost basis was 50% of Mom’s cost
basis.
When sister died and the house transferred back to
Mom, it was considered an inheritance. So Mom’s cost basis on the 50%
she inherited was the market value at the time she inherited it back. So
50% of Mom’s ownership is based on her original cost basis and the cost
basis of the other 50% is the value at Sister’s death.
When Mom then adds Mr. K’s name to the property,
it’s another gift. So Mr.K will inherit 50% of Mom’s new, adjusted cost
basis. When Mom dies and the other 50% is transferred to Mr. K, his cost
basis in that 50% is the value at the time of Mom’s death.
Now you know why accountants make all that money!
Are you like Mr. K and have a financial question
you’d like answered?
If you have a specific question or would like more
information give me a call toll-free at 1-877-827-1463 or you can also reach me by email at
jeff@guardingyourwealth.com.
About Guarding Your Wealth:
“Guarding Your Wealth” is a
nationally syndicated weekly personal finance column written by Jeffrey
D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group,
a private wealth management firm that employs sophisticated proprietary
strategies designed to protect and grow its clients' investments. Please
visit his website,
www.guardingyourwealth.com to read past articles under the Guarding
Your Wealth Article Archive.
Guarding Your Wealth for Seniors are
a collection of columns by Voudrie that deal with issues of particular
interest to senior citizens. Click here
for all columns.
In addition to being a nationally
syndicated columnist and Certified Financial Planning Practitioner, Mr.
Voudrie provides personal, private money management services to clients
nationwide.
Looking for an energetic expert who
is passionate about financial and wealth management? Mr. Voudrie is an
excellent speaker who will excite and inspire your audience. Mr. Voudrie
is available for a limited number of speaking engagements, television
appearances and radio talk shows. For booking information, email e-mail
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