If there is one group of parents who often do much harm to their estate planning it is homeowners. A simple Google search reveals one bad idea after the other and parents who are trying to protect their family often fall victim to the misinformation.
Most everyone wants to avoid probate. If you were to Google “probate avoidance + homeowner” it would not take long to stumble upon some ideas that, while they appear good on their face, actually expose you and your loved ones to major issues. The most common planning suggestion on the internet as a way for your loved ones to avoid probate upon your death is to simply “add your children to your deed.” Let’s discuss this approach in more detail.
Adding Your Child’s Name to Your Deed
It is true that if your child’s name is properly set forth on the deed to your home and you die that property will pass to your child outside of probate. Sounds good. What’s the problem you ask?
First, in NY if you own property with someone to whom you are not married that property is typically owned as tenants in common. What does “tenants in common” mean in plain English? It means that if one of the owners dies their share of the property does not simply transfer to the other owner. Rather, the deceased owner’s share will pass to his descendants through probate.
It is possible to properly title ownership so that each party effectively owns the property as joint tenants with rights of survivorship. While this is not something I advise, for the reasons discussed below, should you wish to title property this way you’ll want to enlist the assistance of an attorney to ensure that the deed is properly drafted. Assuming the deed is properly drafted, upon the death of the first property owner the property will pass to the second property owner, your child, outside of probate. So, what’s the catch with this approach? Tax issues.
Tax Issues of Deeding Property to Your Child
A simple example best explains the tax issues raised when you add your child to your deed. Let’s assume you purchase your home for $100,000. The home is now worth $400,000. If you add your child to your deed this is deemed a taxable gift by the Internal Revenue Service. Let’s assume that upon your death your child sells the property for its current fair market value of $400,000. They will be taxed on the difference between the cost basis of $100,000 and the sales price of $400,000. The tax burden on $300,000 is significant, to say the least!
The Right Way to Do Things
Let’s assume that you did not add your child’s name to the deed and you have a simple will leaving all assets to your child. Upon your death, your child would inherit the property and it would receive a step-up in basis from the $100,000 you paid for it to the then fair market value of $400,000. If your child then sells the property for $400,000 they would owe zero dollars in tax since the sales price equals their basis in the property. They’d have gone through the time and expense of probate but they would have avoided paying tax on a $300,000 gain. This is a huge tax savings!
An Even Better Way
An even better solution, one that avoids not only the tax issue but also the time and expense of probate, is to set up a revocable living trust and have your home titled in the name of your trust. Property titled in the name of the trust avoids probate while still receiving a step-up in basis upon your death. So, if your children are the beneficiaries of your trust they would inherit the property at its stepped-up basis of $400,000, not pay any tax upon the sale while avoiding the time and expense of probate. Truly the best of both worlds!
I wrote this article because of the wealth of misinformation that’s available on the internet. I hope that it saves someone a huge headache down the road. Should you have any questions please don’t hesitate to contact my office.