Question: I am confused about taxes when dealing with our parents’ house. Mom and dad are still living but have moved to a nursing home. The trustee says it’s better to rent the house than to sell it. She says that if we wait for the death of one of our parents, the tax situation will be better. She explained it but I will be sacred if I understand! Will we have income taxes on incoming rent? What about property taxes if we kids want to keep the house in the family?
To respond: It seems that your trustee gives you good tax advice. If your parents have owned their home for a long time, their “cost base” in the home is likely low. If the trustee sells the house now, capital gains taxes will be paid on the difference between what he paid for the house, plus capital improvement costs, and the price at which the house is sold now.
For example, if your mom and dad bought the house for $250,000 and made $100,000 of capital improvements over the years, their base cost is $350,000. If the house is now sold for $1.5 million, capital gains taxes of approximately 20-25% will be due on the difference between the cost base and the amount the house was sold for. . This difference is $1,115,000. So you could pay up to $278,000 in capital gains taxes. Costs of the sale like the real estate agent’s commission are deductions and would reduce tax, but I think you’ll agree that’s still a lot to see going to the government.
If you hold the house until one of your parents dies, the house will most likely get a “full increase” in value on the date of that parent’s death. In our example, if the house is valued at $1.5 million when the parent dies, this is the new cost basis and a subsequent sale of $1.5 million will result in zero capital gains tax. values.
Depending on your parents’ age and health, it may be prudent to own the property and rent it out until you get that solid foundation. Regarding your income tax question, yes, rental income is subject to income tax, but your parents may have sufficient deductions (like medical expenses) to offset the tax.
As for the property tax, if you keep the property, due to the passage of Proposition 19, the property tax will increase upon the death of your parents. It will be reassessed by the county assessor to its current value, and using our same figure of $1.5 million, the annual taxes could be around $15,000 per year. Previously, Proposition 58 protected children from this steep increase in property taxes, but the subtext of Proposition 19 removed that benefit.
There is currently an attempt in California to reinstate Proposition 58 and we could see it on our November ballot. Families who wish to leave their home to their children must vote yes. If the reinstatement passes, you could keep your parent’s base of $250,000 and your annual property taxes would be about $2,500 per year instead of the $15,000 used in our example. Obviously, there are good points on either side of this property tax issue. I simply recommend that voters read the proposals to fully understand what this may mean for their families.
Liza Horvath has over 30 years of experience in the areas of estate planning and trusts and is a licensed professional trustee. Liza is currently President of Monterey Trust Management. It is not legal or tax advice. If you have a question, call (831) 646-5262 or email [email protected]