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Will selling a home in a trust to pay off a mortgage make it difficult to buy a new home?

My husband and I live in a home in a trust that has been paid off (my husband is a trustee). It was my in-laws home, but they gave it to us and moved to a new house. Their current mortgage in their new house is adjusting soon and they can't afford the higher rates, so we are looking into buying their mortgage and putting it in our name. This will technically be our first home loan. If we do this, eventually, we want to sell the home we are in (in the trust) and use the money to pay off their mortgage that we will take on, and move into a new home.

Will we be taxed heavily on using the home trust money to pay off their mortgage? Also, will this sort of transaction make it difficult to get a loan to buy a new home?

Debt, Estate Planning, Real Estate, Taxes
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August 2018

Great question.  Generally, if you have lived in the home as your primary residence for at least 2 out of the last 5 years, when you sell the home you are entitled to a $500,000 exemption on the capital gain (if you file married filing jointly), and so in most cases all or the majority of the sale of the home is tax-free.  However, if the trust that the house is held in is a non-grantor trust or an irrevocable trust that has a separate tax id number and files it's own tax return then the exemption doesn't apply.

So, the taxation on the sale of your home will depend on a few factors:

1) Do you qualify for the home exemption

2) What is the capital gain (sale price of the home - cost basis)

Once you sell the home and pay off your in-laws mortgage your ability to get a new mortgage to buy another home will depend on your debt-to-income ratio and a few other factors lenders look at.