Dear Liz: You recently answered a question about a mother who gave her home to her two children shortly before she died. You wrote that when a home is gifted, the recipients also get the original owner’s tax basis and thus there is no step up in tax basis at death.
However, if the mother continued to live in the home and didn’t pay rent, an argument could be made that it wasn’t a real gift and the home should be included in her estate at death. Then the children could get the step up in basis and not owe capital gains taxes when they sell.
Answer: The estate tax experts at Wolters Kluwer tax research firm agree that if the mother continued to live in the house, IRS Code Sec. 2036(a)(1) could apply, “assuming that there was an express or implied agreement between the mother and the children that she would live in the home rent-free until her death.” Then the fair market value of the home could be included in the gross estate and the children would receive a step up in basis at the mother’s death.
A similar argument could be made if the mother had added the children as joint tenants and continued to live rent-free in the home until death.
Making such arguments to the IRS might require hiring knowledgeable tax and legal help, however. Plus, adding children to home deeds can create other problems. The children’s creditors could go after the house, for example, and transfers of home ownership can complicate Medicaid eligibility.
It would probably be much more cost effective to get tax and legal advice before changing a home’s deed than to hope your heirs prevail against the IRS afterward.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.
