In California, we are blessed with some of the best weather in the United States... and with that weather, comes some of the nation’s highest taxes, and this includes Capital Gains. According to a recent article on Forbes.com, as of January 1, 2024 the California Capital Gains tax is 14.4%, and this is on top of the Federal Capital Gains which could be upwards of 20%. Now keep in mind, we are talking about Long Term Capital Gains. Short Term gains may be higher, and it’s always best practice to speak with your tax adviser as they are your go to professional in this field.Why are we bringing this up? Well, as we previously discussed 1031 exchanges are a great vehicle to defer those tax liabilities to another day. Read the full article on that here. Capital Gains Suck... Let's Defer Them.
Let's talk about a timely scenario that I have run into about 3 times in the last 12 months. You, or someone you know and care about has a parent or parents that are aging in place. Like many, you and they have collectively concluded that they need help and really shouldn't be living on their own. Now what they may need is supplemental income to offset long term care, or their care facility. Let's say that this families house is held in a trust (If it's not, please make every effort to make that happen asap). If both the husband and the wife are alive, it's somewhat fair to say that if they sold their long-term home today, in the Southern California market, they could have significant capital gains on that sale, and those taxes would take a toll on their reserves, and what could be your future inheritance. So... what do you do? One of the best options could be to convert their primary residence into a rental property. By doing this, you will accomplish 2 key components to dodging a large amount of capital gains.
NUMBER ONE: INCOME
Orange County Rents continue to increase and are record highs. This rent can be used to offset the additional expense your parents may have at their care facility.
NUMBER TWO: TAX SAVINGS
By converting their primary home into a rental and ensuring the home is in a trust... the home can then be sold down the road when a family member passes away (Either when one, or both parents were to pass).
At the time of passing, the estate will get what is called a Step-Up in Basis. Based on the Time-of-Death evaluation (or value) the survivor trustee, or the executor is then allowed to sell the property with the increased base, with no tax liability. Now there are some caveats, and yet for the most part, this is a tax-exempt sale (Check with your tax adviser to confirm). If this is not an option that you would consider, and renting out the property is an absolute or resounding NO, then you may want to look into a reverse mortgage. While these were heavily frowned upon in the past, they have come a long way, and this may be a great vehicle to help your parents stay in their home and offset some of their expenses. While it will not supplement them nearly as much, it may still be a great vehicle, and the estate will have the step up in basis a later day... assuming that our government doesn't take that away anytime soon. If you or someone you know, like and care about has any specific questions about what this would look like in a real-world scenario, please feel comfortable connecting with me.
