If I gift the house to them, what are their tax obligations?
The county tax assessor has an exclusion from reassessment for real estate transferred between parent and child up to a total $1M fair market value. You have to fill out a form with the county tax assessor to get the parent-child exclusion.
You will also have to fill out a gift tax return with the IRS, but they have a $5.43M exemption so you won't owe a tax.
Here is a legal guide that may help you: http://www.avvo.com/legal-guides/ugc/transferring-real-estate-documents-required
You'll want to document the gift in a writing as well. You should contact an attorney about this transaction.
You are referring to the $1,000,000 exemption from property tax reassessment. That is if the property is not your principal residence. If it is your principal residence there is no dollar amount limit. If you are married you and your spouse both have $1,000,000 exclusions. Also, the federal gift tax lifetime exclusion is $5,430,000 per donor. The donees do not have obligations; for property tax purposes it is your obligation to file the deed, the preliminary change of ownership report and the Prop. 58 form.
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