I personal a rental dwelling in California. How can I go away it to my daughter so she will be able to keep away from capital beneficial properties taxes?


I live in California and own a single family home with a tenant on a 12 month renewable lease. The house is in a revocable trust.

I want to leave my daughter’s property. I have another child who I do not want to leave any of this property to.

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

How do I shape my will to leave her the property so she can avoid estate and capital gains taxes?


LA landlady

‘The Big Move’ is a MarketWatch column that covers the ins and outs of real estate, from finding a new home to applying for a mortgage.

Do you have a question about buying or selling a property? Would you like to know where your next move should be? Email Jacob Passy at TheBigMove@marketwatch.com.

Dear landlady,

Since I started this column about a year ago, one of the most common questions I’ve got has been how best to make a home for your children. Parents recognize real estate is a useful way of building generational wealth and want to ensure that their children get the most out of their inheritance.

Avoiding an estate makes good sense – it is an expensive process in many states and the fees involved can affect the value of the estate.

However, your situation is a little more complex as the property is not your main residence but a rental apartment. So there are different considerations.

I consulted financial advisors for various strategies that would address your concerns. The first, and possibly easiest, option presented to me by David Bize, a certified financial planner based in Texas, is to convert the title deed into a revocable assignment on the death certificate. 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 property to a specific person, in this case your daughter, without trust. Because of the way the deed is structured, the house would not go by inheritance. Unlike a joint deed, adding to that deed as your Designated Fellow is not a taxable event in the eyes of the IRS.

There are some drawbacks, however. For example, if you become incapacitated as a result of an accident or a health event such as a heart attack, your daughter may not be able to retract the act herself. This could complicate matters as it may be required to qualify for Medicaid.

Giving a house in escrow, like you have already done, is another common strategy people use to evade estate, and one that has been recommended to me by many 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 keeping it. If she inherited it through your will and estate, she would be entitled to an increase. This means that instead of the original purchase price for the rental home, the value of the home at the time of your death is used to calculate the cost base (plus any costs for improvements or maintenance).

If the property has appreciated significantly in value over the years it could make a big difference, and without increasing the base it could be taxed on hundreds of thousands of dollars in profit.

The form of trust is crucial here. “Assets that bypass the estate through a trust or other mechanism are usually not eligible for top-up,” wrote Kristin McKenna, managing director of Darrow Wealth Management, in a blog post. However, a home held in a revocable living trust would likely qualify for the step-up base.

One final strategy recommended by several consultants was to move the house into a limited liability company, or LLC. This way would also be advantageous for you during your lifetime, because it protects your personal assets from liability in the event of financial or other problems in connection with the rented apartment. Also, LLCs can get better tax treatment in some cases.

You can then put the LLC in a revocable living trust or simply include a clause in their operating agreement that provides for your daughter’s succession in the event of your death.

“There can be complications when there is a mortgage on the rental property and this needs to be considered,” said George Gagliardi, founder of Coromandel Wealth Management in Lexington, Massachusetts.

Before starting this plan, it may also be worthwhile to determine exactly what your daughter wants to do with the property after you die. Proposition 19, passed in California in 2020, has some very dire implications for people inheriting valuable investment properties.

“If your children decide to rent your home after they inherit it, they’ll pay property tax on inheritance based on fair market value (the estimated value would be fair value),” Chris Jaccard, senior advisor and partner at financial management firm Financial Alternatives, wrote in a blog post.

Families had until mid-February this year to transfer property to their children and retain the original property tax rate. For example, on a $ 2.1 million home, you might only pay $ 4,000 in annual property taxes, but that would rise to $ 21,000 if your daughter continued to rent it (as it is 1% of the estimated Is worth). at home she could also see property tax increases depending on its value.

If it seems that her best option is to sell the home, she should embark on a strategy that ensures she pays the lowest capital gains taxes. Given the nuances here, I would suggest consulting a lawyer experienced in inheritance law to clarify the terms of the trust in which the house is already held and the tax implications.

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