Dear Tax Guy,
My brother, sister and I inherited a lake house in Texas from my mother, who passed away in 2017.
My sister would like to keep it, but my brother isn’t interested in keeping his share, and I would like to sell or transfer my ownership to my sister.
What would be the most tax-efficient way to sell or transfer ownership to my sister? Are there any other issues to consider with selling/transferring ownership?
Mixing Family and Taxes
Dear Mixing,
The tax provisions here run deeper than the depths of the lake beside your family’s house.
Wading through the tax code is the relatively simple part. Navigating the family dynamics is where the waters could get choppy.
First, the taxes.
This lakefront real estate has surely been growing in value over the last six years, so you must consider the capital gains for any sale that you and your brother are contemplating.
After your mother’s 2017 death, the house’s cost, for capital gains purposes, reset to its market value at the time of her death — in tax-code parlance, that’s known as the “step-up in basis.” Assuming the property has appreciated significantly in value over the years, that could represent a major difference for you and your family.
Now you have six years of asset appreciation. That time frame includes the pandemic’s turbo boost for home prices.
Of course, you and your brother could sell your lake house stakes to your sister. That’s assuming she can pay the full amount upfront, and you’re willing to take the full capital-gains tax hit.
Tax implications
The IRS taxes long-term capital gains at 0%, 15% or 20%, depending on household income. The net investment income tax of 3.8% could also kick in, depending on how much you make.
The net investment income tax can apply to the sale of investment real estate, and the gains on sales of second homes that aren’t the primary residence, the IRS notes.
Charitable contributions could help offset that one-time spike, said S. Michelle Jann, director of wealth planning at Goelzer Investment Management in Indianapolis, Ind.
But that’s assuming you also have the funds and assets to donate, and that it makes sense to itemize your deductions to claim the charitable contributions.
Creating an installment agreement may be another option for your sister, according to Jann and R. Scott Robertson, a Houston, Texas-based partner at Crowe LLP.
It can also make the capital-gains tax hit more manageable as the payments are being stretched out over a number of years, but you will need to prepare for multi-year tax planning that comes with an installment plan, they noted.
Gifting your share
Another option is gifting your share of the house to your sister. That does sidestep a capital-gains tax hit, said Robertson, whose specialties include trusts and estates. Of course, it also sidesteps any economic benefit to you.
If you decide to gift your share, you’ll have to file a gift-tax return, Robertson said. For 2023, the annual gift-tax exclusion is $ 17,000. But I’ll bet your share is worth more than $ 17,000.
The value of your lake-house share counts against your lifetime gift and estate tax exemption, which is $ 12.9 million as of this year. That’s worth knowing if you have other major gifts and estate planning in your future.
Congress nearly doubled the lifetime gift and estate tax exemption in 2017 as one part of the Trump-era tax cuts. Without Congressional action, the exemption — and other major parts of the tax code — revert to the previous rules beginning in 2026.
Regardless, make sure there’s a purchase agreement on paper, as well as an independent appraisal, Jann said. Texas doesn’t have state-level income taxes, but there could be state-tax rules that apply, depending where you live.
Seek out professional tax representation before you proceed.
Beyond taxes
You asked what else you should consider. I’d be remiss if I didn’t discuss the implications for your family relationships. When family members talk about money and weighty transactions, things can go south very quickly.
“Taxes are often the easy part,” Jann said. “Things that are quantitative are often easier than things tied to emotion.” (A dive through MarketWatch’s Moneyist column proves this to be true time and again.)
This was your mother’s lake house. I can see it being the scene for all kinds of lovely family moments. You all may have sentimental attachments, and expectations for how the house will be used if the transaction goes ahead. Will your family still use it from time to time? Would your sister be OK with that?
Proceed carefully with both the IRS and your siblings.
Got a tax question? Write me at: akeshner@marketwatch.com
Thanks for reading. I want to help you think more broadly about the issues that affect your taxes. I’m not offering tax advice, just an attempt to look at what the swirl of tax rules and economic conditions could mean for your wallet.
I’m here for the reader who faces their taxes with an air of resignation. You’re just not that into taxes, I get it. I was once that guy. Underneath the jargon, think of your taxes like a maze — with money at the end. Or a trap that you need to avoid.