Adding Your Child to Title on Your House to Avoid Probate – Good Idea?
Should You Add Your Child to Title or House Deed to Avoid Probate?
The simple answer is no. First, let’s discuss why many of you are considering adding your child to title.
Someone, perhaps an estate planning attorney, has told you that when you die, your assets go through probate. There are certain assets that will avoid the probate process, including: 1) assets that are held in a trust, 2) assets with a pay-on-death beneficiary, and 3) assets held in joint tenancy. Many homeowners want to avoid the cost of estate planning. One solution presented on the internet and by realtors is adding your child to title as a joint tenant. Thus, when you pass away, that property will be transferred to your child without any probate. Sounds good, right? No so fast.
Here are a list of issues that you and/or your children may face down the road by adding your child to title:
Taxes Incurred by Adding Your Child to Title
Estate planning often involves a discussion of many different taxes, including estate taxes, gift taxes, property taxes and income taxes. Income tax is a tax that almost all of us are aware of because we all pay it. When you sell real estate, especially real estate other than your primary residence, you will pay capital gains tax (barring some other tax deferral method such as a 1031 exchange). Capital gains tax is a form of income tax. Essentially, when you sell an asset for more than your purchase price, you pay tax on the difference between your purchase price (your “basis”) and your sell price. With this basic understanding in mind, let’s discuss what happens when you add your child to your home.
By adding your child to title of your home during your life, he or she inherits your basis (the amount you paid) in the house. Therefore, if your child decides to sell the house after your death, he or she will likely incur a capital gains tax for the difference between the price you paid, and the price he or she sold the house. The basis the child inherits is dependent upon the percentage of the gift made during your life. This is further explained in the example below.
If, rather than adding your child to title, you kept the property until your death, and then through a trust, transferred the property to your child, he or she would pay no capital gains tax. The reason is because upon your death, all assets in your name get a step-up in basis to the fair market value. In other words, your child could sell all of your assets the day after your death and pay no income tax.
Example 1: You purchase a house in Orange County for $100,000 in 1975. In 2015, you add your child as a joint tenant on your Orange County home at which time your house is worth $1,100,000. Technically, when you add your child on to your house, you have made a gift of one-half the value of the property ($550,000) and one half of your basis ($50,000). Assuming you died in 2016, when the house was still worth $1,100,000, your child would have a new basis of $600,000. Your child would receive a step-up in basis on your one-half of the property ($550,000) plus his basis from your gift in 2015 ($50,000). If your child decided to sell the house in 2016, he would incur capital gains in the amount of $500,000, creating a tax liability of potentially more than $100,000. Your child has avoided probate, but at a $100,000 price tag.
Example 2: Same house in Orange County is purchased in 1975. However, you keep the property in your revocable trust until your death in 2016. Upon your death, the trust transfers the property to your child. Your child would receive a step-up in basis to the fair market value of $1,100,000. If your child sold the property in 2016, he would pay $0 in income taxes, resulting in a savings of over $100,000. Because your house was a trust asset, your child will still avoid probate.
Clearly, in this scenario, the cost of adding your child to title on your home is tremendous. However, even under different scenarios, the tax consequences will almost always be greater than the cost of simply putting your house into a revocable trust.
It should be noted that when you add your child’s name as a joint tenant on your house, you are making a gift to your child. This gift should be reported on a gift tax return for the year you made the gift. Depending upon your net-worth, this could have adverse tax consequences, including interest and penalties.
Asset Protection
As soon as you add your child’s name to your home, he or she is now an owner of that home. This means that if your child were ever to be sued, perhaps for a contract dispute, or due to a car accident, your house is subject to the claims of your child’s creditors. This means that a creditor could potentially be entitled to at least half of the proceeds of your home. Regardless of how responsible your child is, the more people you have on title, the more potential for creditors to latch on to that asset.
Family Discord and Litigation
When you add your child to your house, the only evidence of your intent is the deed itself. Most importantly, neither a will nor a trust will trump the disposition of the house pursuant to the deed. The lack of documentation of your intent often leads to disagreement between the family. Disagreements often lead to expensive trust and estate litigation.
Hypothetical: You have two children. Child 1 lives with you in Orange County. Child 2 lives in Los Angeles. Since Child 1 lives near you, Child 1 cares for you and visits you often, so you feel that it is fair that he or she receive your house. However, unknown to Child 2, and perhaps to the court, they may see this as you being unduly influenced by Child 1. That Child 1 convinced you to give him or her the house because you needed help. This could lead to a long drawn-out battle in court.
Rather than simply transferring the property by deed, if you visit a qualified state planning attorney, you could avoid these issues, accomplish the same goals, and save your family a lot of money, time and headache.
If you have questions about giving your house to your child, please give us a call at (949) 371-5003, or contact Orange County estate attorney, John L. Wong for an analysis that is specific to your situation.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
