Nj.com’s recent article titled “My mom added us to her deed and then died. Do we owe taxes?” explains that assuming mom retained an interest in the house or lived in the house after putting her children’s names on the deed, the IRS considers the property to be part of the taxable estate of the mother.
That is a critical point, when it comes to the amount of tax the children may have to pay.
She most likely kept a “life estate” in the home. This is where a person owns the property only through the duration of their lifetime. It is called “a tenant for life” or a “life tenant.”
A life estate is a restriction on the property because it prevents the beneficiary (usually the children) from selling the property that produces the income before the beneficiary's death.
When the mom passes away, the life estate automatically stops, and the children now have all the rights associated with the property. As to income tax, when the parent dies, the property receives a “step up” in basis to the date of death value.
If the mom in our example had a life estate, the children would receive a “step up” in basis to the fair market value of the property on the date of death.
That means that the capital gain that would be taxed to the children would be the difference between the fair market value of the property when their mother died and the net proceeds of the sale.
Retaining the life estate can help a child avoid the capital gains tax more effectively than a simple transfer of the property outright to the child.
Talk to an experienced estate planning attorney about life estates and taxes when you inherit a home.
Reference: nj.com (Feb. 18, 2021) “My mom added us to her deed and then died. Do we owe taxes?”