Dear MarketWatch,
I am a California resident. My husband and I own a 1,800-square-foot home that we bought in 2019 for $1.5 million. We have between 40% and 50% equity in the property due to a large down payment.
We are five minutes from our in-laws who have a larger home (around 2,250 square feet) that they bought in 1991 for $450,000. They have seven years left on their mortgage. They are in their 70s and will be downsizing in the next eight to 12 years.
Our hope is to “swap” homes with them. We will be looking for more space around the same time that they will need a single-level, smaller property. What is the best way to arrange for this with minimal tax implications?
Sincerely,
Sweet on Swapping
‘The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.
Do you have a question about buying or selling a home? Do you want to know where your next move should be? Email Jacob Passy at [email protected].
Dear Swapping,
If only more people could find themselves in scenarios where swapping or trading a home were feasible. In the height of the Great Recession, the question of whether you could merely swap homes with someone was asked a lot. Back then, many homeowners found themselves underwater on their homes — owing more to their mortgage lender than the property was worth. That made it difficult to move, because selling the home alone wouldn’t clear the mortgage for these homeowners.
So many folks tried to find people willing to swap homes — enabling them to cut each other deals to make buying and selling a bit easier. Arguably, the strategy is gaining popularity again. Some iBuying companies have programs where you can sell your home to them and then buy one of the homes they’re selling, which promises to make the process cheaper and more flexible.
Indeed many homeowners today might prefer to sell and move if it were that simple. But because there are so few homes on the market, they’re hesitant to do so. I myself have friends who sold their homes because their families grew, but were essentially forced to rent because they couldn’t find an affordable home for sale.
Swapping homes has other benefits besides taking the guesswork out of the process. You don’t need to hire real-estate agents and can save on commissions. And in your case, you might be able to save on the home inspection, even, assuming you’re well informed on the state of your in-laws’ home. So I don’t blame you for dreaming of this possibility.
Assuming your in-laws are game — and, please, be gentle in proposing this idea to them — you’ll want to hire attorneys and accountants who can guide you through the process. Because as you already guessed, there are multiple tax-related pitfalls you’ll need to avoid.
Because you live in California, one of your primary concerns no doubt is the property-tax situation. Before February 2021, the assessed value of a home for property-tax purposes could pass from parent to child when the home transferred between the two. In other words, if a child bought or inherited a home from their parents, they could retain the original property-tax basis. That can represent significant savings, because homes are normally reassessed between owners. In the case of a family home that’s been owned for generations, the value today is likely much, much higher than it was when it was first purchased.
California’s Proposition 19, which went into effect last February, changed that. While it allowed older or disabled homeowners or people displaced by natural disasters to transfer their existing tax-assessed value to a new home even if it was more expensive, it limited the ability to transfer such tax benefits among family members.
“The Prop. 19 rules say that you can pass a principal residence to your children, so long as it was the primary residence of the parents before, and it’s the primary residence of the child thereafter,” Yin Ho, a California-based partner at international law firm Withers who specializes in real-estate law, told MarketWatch in December.
Normally, this transfer occurs via inheritance, but according to the County of Santa Clara Assessor’s Office, it also applies when a parent sells a home to a child (and vice versa). Because both of the homes in question here are primary residences, you should be in the clear.
However, you won’t just keep your in-law’s current tax rate. Rather, a property assessor will determine its current value. If the value at the time of the transfer is less than $1 million greater than the original assessed value, the home will retain that value. From what you’ve described, I’m going to assume that’s not the case.
“Under Proposition 19, an assessor will determine the current value of a home to determine if the person it was transferred to must pay a higher tax rate.”
So for your in-laws’ house, the property will likely be reassessed, but you will get to exclude $1 million from the reassessed value. The exclusion must be claimed at the time of purchase or within a year, according to the San Joaquin County Bar Association.
What that means is if the home’s new value is $2 million, your property-tax base would be $1 million after the exclusion. Therefore, you should keep that in mind when approaching this swap, especially if you wouldn’t be able to afford the property taxes.
Additionally, there capital gains and gift taxes to consider. The Internal Revenue Service will take a keen interest in a situation like this where high-valued real estate is being transferred among family. Consequently, you’ll need to ensure that everything is done by the book so as to not run afoul of the law and be accused of trying to avoid the capital-gains tax.
Along those lines, when you say you want to “swap” homes, you’ll need to decide whether that means gifting the homes to each other or selling them. And if you sell them, keep in mind — any amount below the fair market value can be considered a gift. If you sell the homes to each other for less than they are worth, you’ll need to report the gift to the IRS if the difference in value is greater than $16,000. The lifetime gift tax exclusion, as of 2021, was $11.7 million. You wouldn’t pay any taxes on any gifts made until that amount was reached.
I don’t know your or your in-laws’ full financial picture, but given that you’re discussing transferring millions of dollars’ worth of real estate, you should consider the tax implications of anything you gift to one another — be it property or money.
As I said before, hiring accountants and attorneys will be crucial to ensure that any property transfer happens smoothly. With those professionals in place, you’ll also reduce the chance of hurt feelings if any aspects of the deal become complicated. And keep in mind, your in-laws may have opinions about what you do with the house. So make sure you’re on the same page about this before you move forward. You wouldn’t want your mother-in-law to get upset over repainting a beloved mural, or putting carpet over the hardwood floor she preserved for decades.
I recognize that you’re not planning to trade homes anytime soon either. In the end, you may find it’s better to go the traditional route.
By emailing your questions, you agree to having them published anonymously on MarketWatch. By submitting your story to Dow Jones & Company, the publisher of MarketWatch, you understand and agree that we may use your story, or versions of it, in all media and platforms, including via third parties.