4 Questions to Ask Before Leaving Your House to Your Kids

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You might consider it the perfect gift: You are ready to move out of your home and downsize into a smaller condo or move into an assisted-living facility. Instead of selling the house, you'd like to gift it to one or more of your children.

This is a generous act, but it also comes with some serious consequences. In most cases, if you want to leave your home to a relative, it's best to do so as an inheritance after you die rather than as a gift.

Before you gift your residence, consider these key factors.

The big tax implications

Gifting your children your house might eventually leave them with a big tax bill. The reason is something known as the home's tax, or cost, basis.

How does tax basis work?

When you gift a home to a relative, the original cost of the home is now also considered the cost basis for the person to whom you are giving the residence, even though this person isn't paying anything for it. For instance, if you give your child a home on which you spent $170,000 10 years ago, that property's tax basis remains $170,000, even if an appraiser would determine that the residence is worth $270,000 in today's housing market.

If you give a home to your children as part of your inheritance after you die, though, the tax basis is whatever the home is worth in the current market. Even if you only spent $170,000 on your home, the tax basis of the property would be considered $270,000 if that is what it is worth today.

This subtle difference can have a big impact on the person to whom you've gifted your home.

What about the capital gains taxes?

If your children decide to sell the home you gifted them right away, they could face a big tax hit. If the home's tax basis is $170,000 and your children sell it for $270,000, they'll have to pay capital gains taxes on the profit — in this case $100,000. If you had left the home to your children as part of their inheritance, they could have avoided these capital gains taxes. That's because the tax basis would have been $270,000. If they then would have sold the home for that same figure of $270,000, they would not have had to pay any capital gains because officially the house sale would not have generated a profit.

Your children can avoid capital gains taxes by living in the house that you have gifted them for at least two years before selling it. In this case, your children can skip capital gains taxes on up to $250,000 in profits from the sale of the home. Couples can skip paying capital gains taxes on up to $500,000 on a home they sell if they have lived in it for at least two years.

If you don't know if your children will actually live in the house for at least two years before selling it, leave the home to them as part of their inheritance. It's the better financial move for them.

Is the timing right?

There are times, of course, when you simply can't hold onto a house so that you can leave it to your children as part of their inheritance. In such cases, gifting the house might make sense.

Say one of your children desperately needs a place to live now. Waiting until you die to pass the home to this child won't be much of a help.

Or what if you are moving into assisted-living and can no longer maintain your home? Letting it sit vacant might speed up its deterioration. Your children might be willing to maintain the home until you die and it passes to one of them through an inheritance. Or maybe they'd rather not. Gifting a home to one of your children might be the best way to keep the home in the family.

Are you gifting the mortgage, too?

Gifting becomes more complicated if you still owe mortgage money on the home. That mortgage won't disappear simply because you are gifting the home to one of your children.

The person receiving the home will be responsible for paying the mortgage each month. Make sure this is a financial responsibility that the child receiving the home is willing and able to take on.

Some mortgage lenders might "call in" your mortgage loan when you gift the house. This means that either you or your child must pay whatever the balance is on your mortgage. If this is a small amount, it might not matter. But if you owe a significant amount on your loan and neither you nor your child can pay it, the mortgage lender will have the right to foreclose on your property and take ownership of it.

Make sure that either you or the child who receives the home is able to take care of any mortgage issues.

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