If you are planning your estate, you may think transferring your house to your child may be a smart move to avoid tax implications. In Pennsylvania, this is a straightforward process to accomplish, but in reality, this move carries significant tax consequences that can have substantial impacts on your child’s future liabilities.
Inheritance Tax Issues
Pennsylvania is a state that enforces inheritance taxes, which your child would have to pay if you gifted your home to them during your lifetime, or if received as part of your will, or awarded through probate if you were to die intestate (without a will).
While you can give your Pennsylvania residence to your family, the relationship you have with them will also affect the tax rate they must pay to the state. A good example is the transference of property to your spouse. According to these tax laws, they would owe nothing for inheritance tax, but this is not the case if you leave it to a child who is older than 21 years of age.
According to the Pennsylvania Department of Revenue, the following 2020 tax rates currently apply to individuals gifting their property:
Surviving Spouse – 0%
Children and grandchildren – 4.5%
Parents – 4.5%
Your siblings – 12%
Nieces, nephews, or unrelated persons – 15%
Charities – 0%
Additionally, the state imposes a one-year look-back period where any gifts made the year prior to a decedent’s death would potentially be subject to this inheritance tax. Federal law imposes a three-year look-back period, as well.
Capital Gains Tax Issues to Consider
Another important consideration before transferring property to your child as a gift to preserve your assets from tax implications is capital gains taxation. When someone inherits a property left to them in a will or trust, they don’t face taxes normally imposed on gifted properties. The tax basis of that real estate would be the current value of such property, essentially giving them a “step-up.”
The basis of a property is the amount of money, also known as capital investment, you have invested in your residence, for example. So, when you transfer the family home to your child while still living, and then plans are made to sell it, be aware that there is a potential capital gains tax of up to 20% that could be imposed on the difference between the amount of the sale and the original basis. This could mean a significant amount of tax due that could exceed the 4.5% your child would have only been liable for if he or she had inherited the property from you upon your passing.
Further, your child would have possibly saved on costs through inheriting the home because being part of an estate means its tax liability is adjusted to the current market value at the time of your death.
Speak with an Experienced Pennsylvania Estate Planning Attorney First
On its face, gifting your home seems 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 pitfalls could create financially devastating consequences 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 you can give your house to your child is by sitting down with a knowledgeable estate planning attorney who can assess your estate and help you create an end-of-life strategy that maximizes your assets for your heirs.