Adding an adult child to your house deed might
seem like a smart thing to do. But there's a better way.
Adding an adult child
to your house deed, or giving them the home outright, might seem like a smart
thing to do. It usually isn’t.
Transferring your
house to your kids while you’re alive may avoid probate,
the court process that otherwise follows death. But gifting a home also can
result in a big, unnecessary tax bill and put your house at risk if your kids
get sued or file for bankruptcy. You also could be making a big mistake if you
hope it will help keep the house from being consumed by nursing home bills.
There are better ways
to transfer a house to your kids, as well as a little-known potential fix that
may help even if the giver has since died.
Why you shouldn’t gift a house
If you bequeath a
house to your kids — which means they get it after your death — they also get
what’s known as a “step-up in tax basis.” All the appreciation that happened
while you owned the house is never taxed.
Certified financial
planner Kenneth Robinson of Rocky River, Ohio, says last year he advised a
client not to let his mom give him her house. The mother paid $16,000 for her
home in 1976, while the current market value is close to $200,000. None of that
gain would be taxable if the son inherited the house, Robinson told his client.
The mother signed a
quitclaim to give her son the house anyway and died shortly afterward. That
potentially meant a tax bill of about $32,000 for Robinson’s client.
Families who realize
the mistake in time can undo the damage by gifting the house back to the
parent, says Jennifer Sawday, a partner at TLD Law in Long Beach, California.
“We do last-minute
deeds to get that house back in place when we know someone is dying,” Sawday
says.
Other reasons not to gift a house
Sometimes people
transfer a home to try to qualify for
Medicaid, the government program that pays health care and nursing
home bills for the indigent. But gifts or transfers made within five years of
applying for Medicaid can lead to a penalty period when seniors are
disqualified from receiving benefits.
Transferring your
home to someone else also can expose you to their financial problems. Their
creditors could file liens on your home and, depending on state law, get some
or most of its value. In a divorce, the house could become an asset that must
be divided.
A potential ‘Hail Mary’ fix
Robinson consulted a
certified public accountant and an estate
planning attorney. Both said what Robinson feared was true: The
client was stuck paying taxes on the $184,000 gain in value since his mother
bought the property.
“They were as
discouraged as I was,” Robinson says.
But then Robinson
hired a tax research firm and learned of a workaround. Section 2036 of
the Internal Revenue Code says that if the mother retained a
“life interest” in the property, which includes the right to continue living
there, the home would remain in her estate rather than be considered a
completed gift.
Section 2036 of the Internal Revenue Code says that if the
mother retained a “life interest” in the property, the home would not be
considered a completed gift.
“Many people do not
know about this and are therefore losing out on the step-up and the lower taxes
they would be entitled to,” says Michael Eisenberg, CPA financial planner with
the American Institute of CPAs’ Financial Literacy Commission.
There are specific
rules for what constitutes a life interest, including the power to determine
what happens to the property and liability for its bills. To ensure that
outcome, the son, as executor of his mother’s estate, filed a gift tax return
on her behalf to show that he was given a “remainder interest,” or the right to
inherit when his mother’s life interest expired at her death, Robinson says.
There are better ways to transfer a house
There are other ways
around probate. Many states and the District of Columbia allow “transfer on
death” deeds that allow people to leave their beneficiaries their houses
without having to go through probate. Another option is a living trust, which
typically costs $1,500 to $3,000 to set up but can ensure all a person’s assets
avoid probate.
And probate in many
states is nothing to fear. Most states have simplified probate procedures for
smaller estates. Only in a few, such as California and Florida, is probate so
expensive and time-consuming that most people should try to avoid it.
“We see avoidance of
probate as a big issue in people’s minds, sometimes bigger than it has to be,”
Robinson says.
Liz Weston is a
writer at NerdWallet. Email: lweston@nerdwallet.com. Twitter: @lizweston. This
article was written by NerdWallet and was originally published by The
Associated Press.
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