Due to the rising home prices and the crazy real estate market, it is likely difficult for your children to buy a home. It is conceivable that you are ready to downsize and move out of your current home. If that is the case, you could consider the three options below.

Option 1: Make an Outright Gift

Let us say that you are so generous that you might just simply give your home to your adult child. Tax-wise, if you make the gift this year, it will reduce your $12.06 million unified federal gift and estate tax exemption. To calculate the impact, reduce the fair market value of the home you would be giving away by the annual federal gift tax exclusion, which is $16,000 for 2022. The remainder is the amount that would reduce your unified federal exemption.

If you’re married, your spouse has a separate $12.06 million unified federal exemption. If you and your spouse make a joint gift of the home, each of your unified federal exemptions will be reduced. To calculate the impact, take half of the fair market value of the home minus the $16,000 annual exclusion. The remainder is the amount by which you would reduce your unified federal exemption. The same is true for your spouse’s separate exemption.

If your child is married and you give the home to your child and his or her spouse, you can claim a separate $16,000 annual exclusion for your child’s spouse.

If you expect the home to continue to appreciate, getting it out of your estate by giving it away is a good estate-tax-avoidance strategy.

Option 2: Arrange a Bargain Sale

You are feeling generous, but not so generous that you want to simply give away your home. You could consider selling the home to your child for less than the fair market value. For federal gift tax purposes, this is treated as a gift of the difference between the home’s fair market value and the bargain sale price. From a tax saving perspective, this can work out okay.

Caution.  Do not make a bargain sale or an outright gift of the home if you intend to continue living there until you die. In that case, expect the Internal Revenue Service to argue that the home’s full date-of-death fair market value must be included in your estate for federal estate tax purposes, even if you were paying fair market rent to your child.

Option 3: Arrange Full-Price Sale with Seller Financing from You

The idea of giving your home free to your child might be unappealing. Consider selling the home to your child for its current fair market value with you taking back a note for a big part of the purchase price.

Assume you are feeling charitable. If so, you can charge the lowest interest rate the IRS allows without any bad tax consequences. That is called the “applicable federal rate” (AFR).

AFRs change monthly in response to bond market conditions and are generally well below commercial rates. In April 2022, the long-term AFR, for loans of more than nine years, is only 2.25 percent (assuming annual compounding). The mid-term AFR, for loans of more than three years but not more than nine years, is only 1.87 percent (assuming annual compounding). This arrangement would be a money-saving deal for your child.

Do you know that you could reduce your tax liability by proper tax planning strategy as individual or business owner?

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