If you’re planning on buying a home that you one day wish to pass on to your adult children, a joint purchase can reduce estate tax liability, provided the children have sufficient funds to finance their portion of the purchase. With the gift and estate tax exemption now set at an inflation-adjusted $10 million thanks to the Tax Cuts and Jobs Act (TCJA), federal estate taxes are less of a concern for most families. However, the high exemption amount is only temporary, and there’s potentially state estate tax risk to consider.

Current and remainder interests

The joint purchase technique is based on the concept that property can be divided not only into pieces, but also over time: One person (typically of an older generation) buys a current interest in the property and the other person (typically of a younger generation) buys the remainder interest.

A remainder interest is simply the right to enjoy the property after the current interest ends. If the current interest is a life interest, the remainder interest begins when the owner of the current interest dies.

Joint purchases offer several advantages. The older owner enjoys the property for life, and his or her purchase price is reduced by the value of the remainder interest. The younger owner pays only a fraction of the property’s current value and receives the entire property when the older owner dies.

Best of all, if both owners pay fair market value for their respective interests, the transfer from one generation to the next should be free of gift and estate taxes.

The relative values of the life and remainder interests are determined using IRS tables that take into account the age of the life-interest holder and the applicable federal rate (the §7520 rate), which is set monthly by the federal government.

Consider the downsides

The younger owner must buy the remainder interest with his or her own funds. Also, while the tax basis of inherited property is “stepped up” to its date-of-death value, a remainder interest holder’s basis is equal to his or her purchase price. This step-up in basis allows the heir to avoid capital gains tax on appreciation that occurred while the deceased held the property.

But, in most cases where estate tax is a concern, the estate tax savings will far outweigh any capital gains tax liability. That’s because the highest capital gains rate generally is significantly lower than the highest estate tax rate.