I own a rental home in California. How can I leave it to my daughter so she can avoid capital gains taxes?

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Dear Marketwatch,

I live in California and own a single-family rental property with one tenant with a 12-month renewable lease. The house is in a revocable trust.

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I want to leave the property for my daughter. I have another child for whom I do not intend to leave any of this property.

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My daughter will probably keep the property as a rental, but she may use it as a second home and/or as a partial, week-to-week vacation rental.

How do I structure my will to leave the property to him so that he can avoid paying probate and capital gains taxes?

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la landlady

‘The Big Move’ is a Businesshala column looking at the ins and outs of real estate, from navigating a new home search to applying for a mortgage.

Do you have questions about buying or selling a home? Do you want to know where your next move should be? Email Jacob Passi at [email protected]

Dear Landlady,

Since starting this column about a year ago, one of the most common questions I get is what’s the best way for my kids to leave the house. Parents believe that real estate is a useful path toward building generational wealth, and they want to ensure that their children get the most out of their inheritance.

It’s understandable that you want to avoid probate — in many states, it’s an expensive process, and the fees involved can eat into the value of the property.

However your situation is a bit more complicated, as the property is not your primary residence, but a rental home. So there are different considerations involved.

I’ve chosen financial advisors to find different strategies that address your concerns. The first and potentially easier option, offered by David Bizz, a certified financial planner based in Texas, is to convert the estate deed into a revocable transfer upon death deed. This option became available in California in 2016 and is available in 25 other states as well as the District of Columbia.

This deed allows you to leave your assets to a specified person, in this case your daughter, without the need for a trust. Because of the way the deed is structured, the house will not go through probate. Unlike a joint deed, adding him to this deed as your designated grantor is not a taxable event in the eyes of the IRS.

However there are some drawbacks. For example, if you become disabled due to an accident or a health event such as a heart attack, your daughter may not be able to cancel the deed herself. This can complicate matters, as doing so may be necessary for you to qualify for Medicaid.

Putting a house in trust, as you’ve already done, is another common strategy people use to bypass probate, and one that was recommended to me by several financial advisors.

But there are potential pitfalls — namely in the form of capital gains taxes. After you die, your daughter may want to sell the property instead of holding it. If she inherits it through your will and probate, she will be entitled to a step up on the basis. This means that instead of the original price you paid to buy the rental home, the value of the home at the time of your death is used to calculate the cost basis (plus any expenses associated with improvements or maintenance). Will be done.

If the property has appreciated significantly in value over the years, it could represent a huge difference, and without making a move he could be on the hook for taxes on hundreds of thousands of dollars of profit.

The form that trust takes is important here. “Assets that bypass assets through a trust or any other mechanism typically do not qualify for a step-up,” said Kristin McKenna, managing director of Darrow Wealth Management. wrote in a blog post, However, a house held in a revocable living trust will be eligible for step-up basis.

One final strategy many advisors recommended was to place the home in a limited liability company, or LLC. This route will also benefit you over your lifetime, as it protects your personal assets from liability were there any financial or other problems that may arise with combining the rental home. In addition, LLCs can attract better tax treatment in some cases.

You can then place the LLC into a revocable living trust, or simply create a clause in its operating agreement that sets out your daughter’s succession in the event of your death.

“There can be some complications when having a mortgage on a rental property, so it needs to be considered,” warns George Gagliardi, founder of Coromandel Wealth Management in Lexington, Mass.

Before you work on the plan, it may also be beneficial to find out exactly what your daughter wants to do with the property after you die. Proposition 19, which was passed in California in 2020, has some very serious implications for those who acquire valuable investment properties.

“If your children decide to rent your home after inheriting it, they will pay property taxes based on the market value when they inherit (the appraised value will equal the market value),” Chris Jaccard , lead advisor and partner at wealth management firm Financial Alternatives, wrote in a blog post,

Families had time to transfer assets to their children and retain the original property tax rate until mid-February this year. For example, for a home valued at $2.1 million, you may pay only $4,000 in annual property tax, but that could go up to $21,000 if your daughter continues to rent it (because it’s 1% of the assessed value). Will increase. house, she could also see an increase in property tax depending on its value.

If it appears that her best option is to sell the house, she should choose a strategy that ensures she pays the least amount in capital gains taxes. Given the specifics here, I would suggest consulting with an attorney who is well-versed in estate law to clarify the terms of the trust, what the home is already in and the tax implications.

By emailing your questions, you agree to publish them anonymously on Businesshala. By submitting your story to Dow Jones & Company, the publisher of Businesshala, you understand and agree that we may use your story, or versions thereof, across all media and platforms, including through third parties.,


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