The single most common estate planning mistake in the United States happens when parents put a child’s name on the deed to their house. Parents do this because they want their children to inherit their property without probate costs and delays. Well-intentioned parents do not realize that there are safer, more efficient ways to make sure their kids get their home to help everyone avoid taxes and other complications. If you are about to add your child’s name to your home, keep reading to understand why that probably is not a wise decision and learn about some better estate planning strategies.
The Risks Are Real
Adding another person’s name to your home will be considered an asset that they may need to surrender to creditors. Your paid-off home can become a mortgaged property without you ever having done anything wrong!
As co-owners of your home, your children can also block your ability to get a mortgage or sell the house. They can force you to go to court if they do not agree with your plans. The legal fees generated by this kind of conflict will be nothing compared to the hurt feelings and damaged relationships caused by this rift.
Putting your child’s name on your home can result in thousands of dollars in taxes that they will need to pay after you pass. One of the most significant advantages of homeownership is the favorable tax treatment given to people who inherit real estate.
Federal law gives heirs a considerable tax advantage when inheriting property by extending a “stepped-up basis” to heirs of real estate. Tax law pretends that they “bought” the property for its fair market value at your passing time. Children who sell the property shortly after inheriting it are unlikely to owe any long-term capital gains taxes.
Parents waive this favorable tax treatment by adding their children’s name to the deed of the home. How much does this matter? Imagine someone who bought a house for $50,000 (the “basis”). If the home’s value were $250,000 at the time of their passing, there would be a $200,000 gain. A child inheriting and immediately selling the property would not have any long-term capital gain tax. Still, a child whose name was added to the deed may face tax exposure between the original basis ($50,000) and the value at the time of sale ($250,000). That $200,000 long term gain means an avoidable tax bill of up to $40,000!
Placing your child’s name on your home’s deed can also complicate your taxes. The IRS views that move as a taxable gift of equity unless your children pay the fair market value for the property. You either need to pay a gift tax on the value of the equity you gave away exceeding $15,000, or you will need to file IRS Form 709 with your tax return to apply the gift to your estate tax exemption.
Medicaid’s Look Back Window
Retirees often want to leave their children something as an inheritance and believe that adding their children’s names to their home’s deed is an excellent way to accomplish that goal.
Unfortunately, this move can complicate a retiree’s ability to qualify for Medicaid funded assisted living services. Medicaid examines all property transfers occurring within 60 months of a beneficiary’s application for benefits (California only considers assignments within the past 30 months) and can suspend your eligibility if you gave away too much money before applying for Medicaid. An elder law attorney can help you avoid complicating your Medicaid eligibility while honoring your estate plans.
There are so many downsides to adding your child’s name to your house’s deed that it is a wonder that anyone still does it! There are generally two ways that retirees can avoid the probate process without accepting risks and taxes.
Transfer on Death (TOD) / Beneficiary Deeds
A transfer on death deed functions like a beneficiary designation on a checking account. The property automatically will transfer to your beneficiary upon your death. While they will still need to pay off any mortgages that are on the property, they will not need to go through court or wait months for a claims process to run. While not every state recognizes them, they are becoming more prevalent, and they are an excellent way for many people to pass property to their heirs.
You may also consider using a trust to transfer your property. There are several different types of trust, and you will want to speak with an estate planning attorney before setting one up. The trust becomes the legal owner of your home. When you die, the terms of your trust determine who gets the property or the proceeds of the sale.
The best part of trusts is that there is little room for legal challenges, and they are an excellent way to protect a minor’s inheritance. The biggest drawback to using a trust to transfer your home to your heirs is that they can complicate mortgages. Set up the trust incorrectly, and your mortgage’s due-on-sale clause may be triggered, forcing you to pay the home off immediately! Not to worry, an estate planning lawyer will help you avoid this.