Legal Question in Wills and Trusts in California

Most likely you would need to file a gift tax return but not pay any gift tax. Capital gains tax is not due until the gain is "realized" ie a sale, but your son would not get a stepped up basis from a gift as he would if he inherited the property. You should consult your CPA.

Giving away real property to children is one of the most complicated, and almost always (not always, but damned near) the most foolish things a parent can do, from a tax and estate planning standpoint. If there is more than $13,000 in equity in the property, you (not your child, but rather YOU) will be liable for gift tax on any equity above $13,000. If you and your spouse jointly own the property, that goes up to $26,000. Now if your child is married and you give it to both of them, then you can exclude $52,000 in equity from gift tax. BUT OOOOOOPPPPS, since the spouse is not your child, the parent/child exclusion from Prop. 13 property tax reassessment would be lost for her half. Oh, and what if the child is your child but your spouse's step-child? Again, there would be property tax increases even if you only give it to your child, because it's not your spouse's child. Then there is the REALLY big tax issue: capital gains. This is bad enough with, say, the family home. When it's rental property the issue is huge because all that nice depreciation you've been taking has eroded your basis. Say you bought a property for $275k, and it's now worth $650k, but you lived in it. Not only do you pay gift tax on $375k, when your child goes to sell it he will pay capital gains on that amount at about 25% combined state and federal (though he may get the $250k exclusion he'll still pay it on $125k). If you think that's bad, check out the rental property results. On that rental, you would be taking between $8k and $9k per year in depreciation. If you've been renting it for ten years, let's say for round numbers you've taken $100k in depreciation. So now your basis is $175k which you pass on to the child. They now face capital gains on all but $175k when they sell. And if they sell having lived in it for less than two of the last five years they don't even get the $250k exclusion. And last but not least, if you don't own the property outright, deeding it to the child without him refinancing would be an event of default on your mortgage. So what's a parent to do? Put it in a trust or will it to the child. Unless your entire estate is over $5million there's no estate tax so you avoid the gift tax. The property taxes are not reassessed at all if it only goes to the child, and if it goes to the child and spouse, or from a parent and step-parent to child, you still avoid the higher taxes until you pass away. And the big pay-off is the capital gains tax. If the child receives the property from a trust or will on your death, the basis gets reset to the market value on the day they get the property (the "stepped up basis" Cusack mentioned). All the depreciation and appreciation from when you bought it is wiped out and the kid gets the property with no capital gain and depreciation recapture at all except for gains after that date.