The Estate Planning Secret the IRS Doesn’t Want You To Know, According To John Liang
Written by
Jordan Rosenfeld
Edited by
Levi Leidy
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Parents who are in the fortunate position to pass on a home to their kids after death often feel good that they’re leaving their beneficiaries in a positive financial situation.
However, according to TikTok finance influencer John Liang, who achieved “financial freedom” at the age of 31, you could actually be setting your kids up for big tax bills if you don’t do it in the right way.
He explained what the IRS doesn’t want people to know about the best way for parents to leave a home to kids, especially if they plan on selling that home.
The Problem With a Simple Inheritance
If you bought a house for $100,000 at a time when homes were a lot cheaper, and you’re excited to give your kids this house that is now worth $500,000 so they can sell it for financial gain, you could be setting them up to pay significant capital gains taxes.
The Capital Gains Tax
The capital gains tax is what the IRS imposes on the earnings of an investment. It applies to all kinds of investments, from stocks to real estate.
So, if you bought the house for $100,000, leave it to your kid and they sell it at its current market value of $500,000, they could pay capital gains taxes on the earnings of $400,000. The capital gains tax varies based on your income and marital status but can be as high as 20%.
Some exceptions do apply. Those who are single and earn less than $47,025 will not pay capital gains taxes. But earn just $1 over that and you jump to the 15% capital gains tax bracket. Additionally, some people may be able to take advantage of the home sale tax exclusion, which excludes $250,000 of the gain from your income for an individual and $500,000 for married couples.
Set Up a Living Trust
Don’t panic — here’s what you can do if you’re worried about your kids having to pay these taxes. Liang suggested you set up a living trust, essentially a document that states how your estate will be disbursed, in which you can set specific parameters.
Next, you name your kid(s) as the beneficiary after your death, and you set up the property to be passed on as a “step-up in basis.”
A Step-Up in Basis
A step-up in basis allows the home’s cost-basis to be reset to the property’s fair market value, rather than the value it held at sale of purchase.
So, if the original value of the home purchase was $100,000 and the sale would be for $500,000, that’s $400,000 in earnings that could be subject to capital gains taxes. If, instead, the reset value (the step-up) is set to the current value, $500,000, your beneficiary now does not owe capital gains taxes. Or even if the step-up is less than the current value, it’s still likely to close a significant earnings gap.
In other words, instead of paying capital gains taxes on the difference between $100,000 and the sales price, you would now pay capital gains tax on the difference between the likely higher assessed value and the sales price.
This way, everyone benefits — you get to pass on your home, your child can sell it without paying exorbitant taxes and you can rest in peace.
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