Q: We have a condo that we will gift our granddaughters when and if they graduate from the Air Force Academy a few years from now. Since my wife and I can gift $12,000 a year to each of our two granddaughters, in four years we would be able to completely transfer the property, which is worth about $196,000, and avoid any gift tax.
How would you recommend we do this?
A: You sound like great grandparents, so I want to give you the pros and cons of what you are proposing.
First, as of January, the annual gift exclusion is now up to $14,000. So, if you decide to go this route, each year you and your wife can gift $56,000 worth of the property to your two granddaughters. If the property value stays under $224,000 — and the current exclusion number stays the same — you can complete the transfer within four years.
You will need an appraisal to document the value of the property at the time of each gift. In other words, every year, since you will be making a separate gift, it is recommended that you get a new appraisal, which, if done by the same appraiser, should not be that expensive.
Procedurally, you and your wife would physically deed your two grandkids the equivalent of one-fourth of the property each year. Make sure that the value does not go over the $56,000 cap. I would also have an attorney review and prepare the necessary documents.
That's the positive. Now for the possible negative.
First, do you have a mortgage on the condo? If so, I am sure there is what is known as a "due on sale" clause, which could trigger your lender calling the entire loan due. So discuss this with the lender; they shouldn't object, but they should be informed of your plans.
Next, how will your two granddaughters take title? What if one or both get married? What if one wants (or needs) to sell? If you go this route, they should enter into a partnership agreement spelling out the various aspects of property ownership.
Finally, in many cases, such a gift could be a disservice to the granddaughters. When you gift them the property, your basis for tax purposes becomes their basis. So if you bought the property for $100,000, that's their basis. If they sell for $300,000 down the road, unless they can qualify for the up to $500,000 exclusion of gain (or up to $250,000 if they are not married or file a single tax return), they will have to pay a lot of capital gains tax.
And if Congress ever gets its act together, I strongly suspect that the current 15 percent capital gains tax will either be repealed — in which case you pay ordinary income tax on any profit — or the cap will be raised to 20 or even 28 percent.
But if you die, and your grandkids inherit the property, under current law they get what is known as the stepped-up basis. In other words, their tax basis is the value of the property on the day you died.
So, my firm suggestion: Let them inherit the property, and leave it to them in your wills.
There is another possible way to resolve the matter: You can sell them the property, and be the lender and take back financing. This way, their basis is the purchase price, which can be the market value less a 6 percent real estate commission.
The only drawback here is that you will have to pay tax on any profit you will have made.
Please talk with a financial counselor to assist you in determining what's best for you — and your granddaughters.
Benny L. Kass is a practicing attorney in Washington and Maryland. No legal relationship is created by this column. Send questions to firstname.lastname@example.org.