For many parents in their 60s and 70s, the family home is the largest asset they own, and much of its value is decades of appreciation. Whether to sell it, give it to the children, or leave it to them at death can change the family’s tax bill by tens of thousands of dollars. The key idea is the step-up in basis, and how it compares with the home sale exclusion the parents can use if they sell.
Here are the three paths, worked through with one example.
The example
Joan and Robert bought their Blue Bell home in 1988 for $180,000 and have since put $120,000 into improvements, including a new kitchen, roof, and windows. Their basis is about $300,000. The home is now worth about $1,000,000, a gain of roughly $700,000.
Path 1: They sell it themselves
As a married couple who have lived in the home for years, they can exclude up to $500,000 of gain under Internal Revenue Code section 121.
- Gain: about $700,000
- Excluded: $500,000
- Taxable capital gain: about $200,000, before selling costs reduce it further
This is often the right choice when the parents want to downsize, need the money, or want to simplify. Keep records of every improvement, because each one raises the basis and lowers the gain. The guide to taxes when selling your home in retirement goes deeper.
Path 2: They give it to the children now
A lifetime gift passes along the parents’ basis. Under section 1015, the children’s basis would be about $300,000, the same as Joan and Robert’s. If the children sell for $1,000,000 and never lived there, the taxable gain is about $700,000, and they cannot use the parents’ home sale exclusion.
A lifetime gift of an appreciated home is often the most expensive option for income taxes. It can still make sense for other reasons, so it is a conversation for the family’s attorney.
Path 3: The children inherit it
Under section 1014, inherited property generally takes a basis equal to its fair market value on the date of death. If the home is worth $1,000,000 when the last parent dies, the children’s basis becomes $1,000,000. If they sell soon after for about that price, there is little or no capital gain.
| Path | Children’s basis | Approximate taxable gain on a $1,000,000 sale |
|---|---|---|
| Parents sell | Not applicable | About $200,000 for the parents |
| Gift during life | About $300,000 | About $700,000 for the children |
| Inherited | About $1,000,000 | Little or none |
Two important wrinkles
When one spouse dies first. In Pennsylvania, which is not a community property state, a home owned jointly by a married couple generally gets a new basis only on the half that belonged to the spouse who died. A surviving spouse who has not remarried and sells within two years of the death can still use the full $500,000 exclusion.
Pennsylvania inheritance tax. The home is taxed when it passes at death: 0 percent to a surviving spouse, 4.5 percent to children and grandchildren, 12 percent to siblings, and 15 percent to others. On a $1,000,000 home passing to children, that is about $45,000, reduced by 5 percent if paid within three months. Pennsylvania also reaches back for gifts made within one year of death above $3,000 per recipient.
It is not only about taxes
Many families find the tax answer points one way and life points another:
- A large home may be more than the parents want to maintain, and the equity may fund the next chapter.
- The children may not want the house, or may live far away.
- Leaving a home to several children can mean a shared decision about selling later.
The guide to downsizing in the Philadelphia suburbs and the guide to using home equity in retirement cover those choices. When children do inherit, the guide to capital gains on an inherited home explains the sale.
Where Karen fits
Karen Langsfeld is a REALTOR® and Pricing Strategy Advisor (P.S.A.) with Berkshire Hathaway HomeServices Fox & Roach, and a resident of Montgomery County. She prepares comparative market analyses that give families and their accountants real numbers for comparing these paths, prepares date-of-death market analyses that estate attorneys use alongside a formal appraisal when one is required, and sells homes for parents and heirs alike. Learn more about helping your family buy or sell a home.
Contact Karen at (215) 495-2914 or through the contact page.
This guide is general information, not legal or tax advice. Your situation depends on your full estate plan; confirm it with your attorney and accountant. Sources: Internal Revenue Code sections 121, 1014, and 1015; Pennsylvania Department of Revenue, Inheritance Tax; Pennsylvania Tax Reform Code sections 2107, 2116, and 2142.