Should you sell your home or keep it for your heirs?

Are taxes the only issue?

In our previous article, "Estate Planning for Your Primary Residence," we discussed issues such as: Who Gets What; Debts and Liabilities; Capital Gains Tax (for any increase in value since property was inherited); and Property Taxes (in particular, the impact of Prop. 19). In this article, we'll move on to one of the most common questions we hear from clients on the subject, which is "Should I sell my house before I die or leave it to my heirs?"

Our clients are typically concerned about estate taxes for their heirs and how to minimize them. Under current tax laws, the key estate tax consideration is capital gains taxes, in particular during your lifetime or for your heirs. From capital gains tax and probate perspectives, selling or holding your primary home depends on the current market value of the home vs. your tax basis, your capital gains tax exposure, and potential probate costs for your heirs.

Taxation for Your Heirs

If your home has appreciated significantly, holding it until death can result in a substantial tax advantage for your heirs. With proper estate planning it would generally mean no capital gains tax for your heirs if the total estate is less than the basic exclusion amount, except for taxes due on any gains made since it was inherited.

This involves what is called a "double step-up" in basis in a community property state (see previous article for details). So, if you hold the home and give it to your heirs, they will receive a "step-up in basis" which means their new tax basis becomes the fair market value of the home at the passing of the last survivor. This can save a tremendous amount in capital gains taxes.

What if You Sold Now?

Many of our clients purchased their homes several decades ago, hence they would encounter substantial capital gains tax if the home was sold during their lifetime.

Consider the case of John and Susan, who bought their home in the 1990s for $300,000. Over the course of the next 30 years, they paid for a home expansion, extensive landscaping and several major remodeling projects, totaling $200,000. This resulted in a basis of $500,000. They put their home on the market and were pleased to sell it for $1,900,000. After closing costs of about $150,000 including realtor's commissions, their net proceeds were $1,750,000. Their gross capital gain was $1,250,000. However, they qualified for the home sale exclusion of $500,000 as a married couple filing jointly, so capital gain was adjusted down to $775,000. This amount is now subject to federal and state taxation.

Of course, if someone purchased a home under a different scenario, they might have minimal capital gains exposure; every situation is different. For example, if your total gain is modest and you qualify for the homeowner exclusion, selling it during your lifetime could make financial sense and avoids it being in probate. You would have immediate liquidity to distribute the proceeds directly to loved ones or use the funds for retirement.

Note: Under H.R. 1340, congressional representatives are seeking to raise the capital gains tax exclusion to $500,000 single/$1,000,000 married filing jointly, with annual adjustments for inflation. This bill is in the early stages of the legislative process, but if passed it could impact timing of selling your primary residence (i.e., waiting for the bill to pass).

Non-Tax Considerations

Of course, taxes aren't everything. Instead of conforming estate planning to the sole goal of tax minimization, many trustees balance it with other objectives, including:

Enjoying the equity built up in their home. This is a major factor in California, where it is common for a home to be the largest financial asset in net worth. If they need cash and can't get it elsewhere, some couples take out home equity loans (although many prefer to avoid such debt later in life). Some couples simply can't afford to retire unless they sell their home. If the sell decision is made, the pent-up liquidity from a home sale can now be used for buying a smaller home, supplementing cash flow for a more enjoyable retirement, traveling while health is still good, helping children with down payments, paying for grandkids' education, etc.
Time to downsize? Others decide to downsize and buy a much smaller home, sometimes out-of-state, where property taxes and the cost of living may be lower. This decision also might result in decreased maintenance responsibilities and costs, and more flexibility in lifestyle choices.
Adult children still living at home. This is an increasingly common concern, as housing costs have forced many young families to move in with parents. In such scenarios, it may seem unfathomable to sell the home until your adult children are able to move out.
Surviving spouse wishes to sell. While some widows would like to stay at their home until they pass on, others find it too difficult. This can be because it is too much to take care of, they wish to move closer to family, or other emotional and personal issues.
Simplified estate planning for heirs. You might find that it is easier for your heirs if you make the decision to "sell the family home." Family legacy and sentiment can sometimes be difficult and may cause conflict.

WE UNDERSTAND THE IMPORTANCE OF YOUR ASSETS

At Mortensen & Reinheimer, PC we realize that your assets represent years of hard work and can hold not only financial but also sentimental value. We know that our clients may have specific goals for certain assets and beneficiaries and need legal guidance in how to best achieve these objectives. Please contact Mortensen & Reinheimer, PC at (714) 384-6053 to make an appointment, or use our online contact form. Our website is http://www.ocestateplanning.net.

About the author:
Tamsen R. Reinheimer, Attorney, is a Certified Specialist in Estate Planning, Trust & Probate Law (The State Bar of California Board of Legal Specialization). She has significant experience in all aspects of estate planning, trust administration, and probate. Contact Tamsen at tamsen@ocestateplanning.net.