My late mother passed her condo onto me through a quitclaim process 10 years before she died. I was told by my income tax preparer that she should have paid some kind of a tax. But she never filed income taxes for years as she was not required to because of her low income and was not advised to do so by her estate financial planner who took care of the quitclaim process for her.
Also, I live in California as did my mother. I read online that according to state law, should I sell the condo, I would only receive what it was worth at the time of the quitclaim and have to pay taxes on that amount. Is this true? My late mother originally purchased it with cash 26 years ago. Currently, I am renting it through a property management firm.
What will be the implications to me, if any, such time as I should sell it?
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Quitclaim deeds can come in handy as a workaround in real-estate transactions in very specific instances. However, there is a degree of finesse required to make sure everything is kosher, as it seems you are now discovering well after the decision was made.
So what is a quitclaim deed? It’s a transfer of deed where there’s no warranty, or protection, for the property’s title. Essentially, the grantor — your mother in this case — gave you the rights to her property and put it in your name.
The main risk involved with this type of transfer is that the grantee, or the one receiving the deed, is only entitled to whatever the grantor was entitled to. So if someone else actually owned or had a claim to the property, the quitclaim deed could be worthless. As a result, legal experts only advise that people pursue a quitclaim deed if they know and trust the other party, as you did with your mom.
One of the benefits of a quitclaim is that the property transfer isn’t always subject to the same taxes as a typical property transfer. But that doesn’t mean it’s tax free. I have two guesses about which taxes your accountant was mentioning. He could have been referring to the document transfer tax that must be paid when filing the deed — unless the quitclaim paperwork specified an exemption to this.
“ One of the benefits of a quitclaim is the property transfer isn’t always subject to the same taxes as a typical property transfer, but they aren’t tax-free. ”
But what appears to be the more likely issue here is that your mother never filed a gift tax return. Because no money changed hands between the two of you when she signed her condo over to you, the transfer is considered a gift.
There is a lifetime exclusion for gift taxes, meaning that any gifts below that amount aren’t subject to taxation. As of 2021, the lifetime exemption is $11.7 million, meaning that if the total sum of gifts a person made over their life is lower than that amount, they won’t be forced to pay taxes on them.
There are also annual exclusions. The annual gift tax exclusion for 2021 is $15,000. If a gift is larger than that amount, then a gift tax return, called a Form 709, must be filed (unless the gift was made between spouses, in which case it’s exempt), along with any supporting documentation regarding the gift. This doesn’t mean a tax would need to be paid, unless the amount of the gift was higher than the lifetime exemption.
From what you’ve described, it sounds like your mother never filed a gift tax return for the quitclaim. She should have done so, even if she wasn’t required to file an income tax return because of her low income. Her failure to do so means she could have been subject to penalties from the Internal Revenue Service. If she had an accountant, they too could be liable for penalties.
According to the IRS, there are penalties “for willful failure to file a return on time, willful attempt to evade or defeat payment of tax, and valuation understatements that cause an underpayment of the tax.”
If you were not contacted by the IRS, there’s a chance that they never learned of the quitclaim. However, that doesn’t let you off the hook. My advice would be to contact a tax lawyer who can determine whether you owe the IRS any money and to settle the matter.
As for your second question, a capital gains tax applies to the proceeds of a home sale. The capital gains is typically the difference between the price a person paid for a home and the price they sold it for, minus the cost of home improvements. The size of the tax rate depends upon a person’s income and filing status. Here, too, there are exemptions.
“ With home received via a quitclaim, the calculation of capital gains is more complicated. ”
For a single person, the first $250,000 of profit from the home sale based on that calculation is exempt from being taxed, if the home was their primary residence. To qualify as a primary residence, they must have lived in the home for at least two of the last five years.
With investment properties, like your late mother’s condo, there are other ways to avoid the capital gains tax, such as a 1031 exchange. Under this approach, the proceeds from the home’s sale must be reinvested to avoid paying taxes, though there are specific rules that apply.
The implications for you when you sell the condo will largely depend on how the property was used, as I’ve just laid out, and what the cost-basis of the home was.
That’s where the quitclaim process your family took complicates matters. “While California does allow you to transfer your property to children via a quitclaim deed, doing so can adversely affect your child if they ever want to sell the property,” California-based law firm Lynk Law wrote in a blogpost.
Had your mom simply left you the home in her will, you would have received a step-up in basis. What that means is when you went to sell the home, the “cost” of the home for you when calculating how much you profited would have been based on its value at the time of your mother’s death.
Instead, because you took the quitclaim route, your profit will be based on how much your mother paid for the condo when she originally purchased it. That could make the capital gains from the sale of the home much larger if, for example, she purchased the home in 1980 for $100,000 and it was worth $400,000 when she died. To ensure you lower your tax liability on the sale of the condo as much as possible, whenever you do decide to sell it, it would be worth hiring a tax expert to walk you through potential exemptions.
I don’t want you to take in this information and regret the choices you and your mother made, as I am certain she only wanted the best for her child. It’s possible that turning the condo into your primary residence for a couple of years after the current tenants move out could be one way to ensure you get the most out of this wonderful gift your mother left you.