If you are planning your estate in Pennsylvania, you may think that it would be a smart move to transfer your house to your child in order to avoid tax implications. This process is straightforward, but in reality, it carries significant tax consequences that can have substantial impacts on your child’s future liabilities.

Can I Transfer My House to My Child, Tax-Free?

Yes, in Pennsylvania there is no transfer tax on property transferring from an individual to their direct descendant(s): in this case, from parent to child. Although the transfer may be tax-free initially, your child will be subject to other taxes down the road, particularly the Federal and Pennsylvania Capital Gains Tax and/or the Pennsylvania Inheritance Tax.

Tax Implications of Transferring Ownership

There are significant tax liabilities in Pennsylvania that are associated with the transfer of a home from parent to child.

Capital Gains Tax

Probably the tax with the largest liability associated with property transfers is the capital gains tax. This tax is imposed on the gains from the sale, exchange, or other disposition of any kind of property, under the federal income tax law and the PA Personal Income Tax (PIT) law. The amount of tax is computed by subtracting the original value of the property at the time of purchase from the current market value of the property at the time of sale or disposition and multiplying that value with the appropriate tax rate (based on income bracket).

Inheritance Tax

If a parent transfers their home to their child and passes away less than a year after the transfer has been completed, the child will be responsible for paying inheritance tax on the home’s value. The tax rate for assets passing from a decedent to their child, who is older than 21 years of age, is 4.5%. On the other hand, if your child predeceases you and you are the beneficiary/heir of the home, you (the parent), will be subject to paying inheritance tax on the asset, with a rate of 4.5%.

The Stepped-Up in Basis and Calculating Taxes Owed

When considering tax implications of transferring your house to your child, it is important to also understand the concept of “stepped-up in basis.” This concept resets the cost basis, which is a factor in determining the amount of taxes owed, of an inherited asset from its purchase price to its current market value at the time of the owner’s passing or sale of transferred property.

Capital Gains Tax & the Stepped-Up Basis

Let’s say that Susan paid $70,000 for her house 20 years ago and now that she is getting older she decides to transfer the property to her son, Eddie. After a few years of owning the home, Eddie decides to sell the property. At the time of sale, the property’s fair market value is $135,000. Because the property is selling for more than it was originally purchased for, Eddie is responsible to pay a capital gains tax on the $65,000 appreciation of the property, at a rate of 15%. So, Eddie owes $9,750 in taxes on the sale of the home.

Inheritance Tax & the Stepped-Up Basis

What if Susan hadn’t transferred the property to her son? If she had left the house to her son in her will or trust, Eddie would instead be subject to the Pennsylvania Inheritance Tax. With consideration to the stepped-up basis, the current fair market value of the home would be used to calculate how much tax is owed on the inheritance of the property. As stated in the example above, the current fair market value of the property is $135,000. Assets transferring from parent to child in Pennsylvania, given the child is over 21 years of age, are subject to an inheritance tax rate of 4.5%. So, Eddie would have to pay $6,075 in taxes on the inheritance of his mother’s home.

Consult with an Experienced Estate Planning Attorney

At first glance, transferring your house to your child seems like a feasible way to avoid losing valuable dollars and asset value in Pennsylvania. When you truly examine the process, you will quickly learn this is not the case. Numerous tax implications could create financially devastating consequences for your child that may even lead to the loss of your residence altogether, due to your child’s inability to pay exorbitant tax fees when taking over the property.

The best way to make sure that transferring your house to your child is the right solution for your situation is by consulting with a knowledgeable estate planning attorney who can assess your estate and help you create a strategy that maximizes your assets for your named beneficiaries. If you have any questions or would like to learn more about the process of transferring ownership of your home to your child, the team at Antanavage Farbiarz is more than happy to help. Call our office at (610) 562-2000 or click here to schedule a consultation with one of our seasoned estate planning attorneys!

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