My father has been retired for 30-plus years and owns a home worth $1.8 million outright. He is 84 years old and ready to move to a retirement community to simplify his life. The home is in Sunnyvale, Calif. (where I also live and own). He plans to move to Denver, Colo. near my sister (a wonderful caretaker). He will purchase a $400K condo that he can easily pay cash for.
Our family is close. My sister and I are his only heirs and weâve discussed his wants and needs for the future. His trust simply grants us both 50% each of all of his assets. My sister and I are very close and already own rental properties together so we are comfortable being in business together.
How do we deal with the Sunnyvale home? Should he keep it and rent it for $4,000 per month until he passes or should he sell it now? The tax burden he would have if selling seems tremendous, but we arenât sure of the tax and other impacts of inheriting the property when he passes.
We have total flexibility as we are financially stable and looking forward to retirement in a few years. Iâm 55 and my sister is 57. What tax implications would my sister and I have if we inherited the property and then quickly sold it?
Ken in California
First , the bad news.
If you were gifted the property while your father is alive, not only would you be excluded from the $250,000 capital gains exemption relating to the sale of a personal residence, you would assume your fatherâs basis in the property and pay tax on the full capital gain generated from the sale.
Assuming the property was originally jointly owned by both parents, your dad would have a step-up in basis after your mother died. And you and your sister will receive a step-up in basis gain after your father dies, says Gerald Wolanin, a CPA in Willoughby Hills, Ohio.
Your father gifting the property to you and your sister would be âinadvisable,â as you and your sister would be subject to full capital gain tax on the sale as your fatherâs personal residence sale exclusion would be lost.
Say you inherit the property and itâs still worth $1.8 million. If it appreciates in value to $2 million when you sell it, you will only have to pay the capital gains tax on that $200,000 appreciation in value for the time that you actually owned the property.
For that reason, your father gifting the property to you and your sister would be âinadvisableâ from a tax perspective, as you and your sister would be subject to full capital gain tax on the sale as your fatherâs personal residence sale exclusion would be lost.
âIf converted to an income-producing rental property, the potential exists for a future sale and reinvestment of the property under provisions of IRS Code Sections 1031,â he says. (Currently, itâs not income-producing, so you canât defer the gain from any sale.)
IRC Section 1031 allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange, according to the Internal Revenue Service. Any gains are tax-deferred, but not tax-free. Obviously, consult a CPA or financial adviser.
IRC Section 1031 allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange, according to the Internal Revenue Service.
If your father vacates the property for any reason, it becomes non-owner occupied, Wolanin adds. So make sure you have the correct insurance in place. âChange to non-ownership status increases the risks to the insurer and can result in a denial of claims,â he says.
Finally, I commend you for planning ahead and for working so closely with your sister. You wouldnât believe the number of letters I receive involving sparring siblings and families broken apart over an inheritance. A capital gains tax on the appreciation of this home is a small price to pay.
Thatâs the good news.
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