Let’s say you’re getting older and you’re concerned about passing on your home to your children. Some people add their children’s names to the deed to their home so that when they pass away, the child will receive the home without having to go through probate. But this complex real estate transaction carries significant legal and financial implications that can greatly affect you and your heirs. It may not be the best solution.
Complications
Many times, people add their children’s names to the deed of the family home to avoid probate or prevent the family home from being sold to pay for nursing home expenses. But this can lead to unfortunate consequences.
Co-owners
First, when you put your children’s names on the deed to your home, you are giving them an interest in your real property. They now become co-owners with you in your home. This means they, like you, have the legal right to sell, devise, or encumber (take out a loan) their interest in your home. It also means that if you want to sell your home, you must get your children, as co-owners, to agree.
What if the child whose name you put on the deed to your home is married? They can give, sell, or bequeath their share in your home to their spouse. Would you want that? What if the child you put on the deed passes away and leaves their interest to their spouse or a friend? You could end up co-owning your home with your daughter-in-law, son-in-law or a complete stranger.
What happens if your married child divorces? If your child acquired title to the home during the marriage, depending on the laws in you state, their interest in your home may be subject to division by the family law courts. In other words, your daughter-in-law or son-in-law could be awarded half of your child’s interest in your home as part of the divorce.
Capital Gains Tax
Putting your children’s names on the deed to your home can also lead to tax complications. When you put your child’s name on your deed, for tax purposes, they will be considered to have acquired their portion of the home at the same price you paid for the house. If, at the time of your death, your child sells the home, he or she will have to pay capital gains tax on the part of the home they acquired before your death.
Depending on how much equity you have in your home, the capital gains tax consequences for your child could be considerable. In contrast, if your child inherits his/her portion of the home at the time of your death, they acquire the home based on the date of death value. When they go to sell it, there will be no capital gains tax unless it has gone up in value from your date of death until the date of sale.
Here’s a real world example. Say 30 years ago, you bought your home for $100,000 and today it’s worth $600,000. You put your child’s name on the deed today. You pass away next month and your child decides to sell the property. Their basis in the property is $100,000 and they sell it for $600,000 which is a $500,000 profit. They would owe capital gains tax on the $500,000 profit. If they fall in the 15% long term capital gains tax rate, that would be $75,000 in capital gains tax.
Now let’s say you did not add your child’s name to the deed, but instead they inherited the property when you passed away. Because they inherited the property, their basis in the property would be the date of death value which is $600,000. If they sell the property for $600,000, there is no profit and ZERO capital gains tax. That’s a savings of $75,000 in capital gains tax!
2024 Long-term capital gains tax rates
| FILING STATUS | 0% RATE | 15% RATE | 20% RATE |
|---|---|---|---|
| Source: Internal Revenue Service | |||
| Single | Up to $47,025 | $47,026 – $518,900 | Over $518,900 |
| Married filing jointly | Up to $94,050 | $94,051 – $583,750 | Over $583,750 |
| Married filing separately | Up to $47,025 | $47,026 – $291,850 | Over $291,850 |
| Head of household | Up to $63,000 | $63,001 – $551,350 | Over $551,350 |
Creditor’s Claims
As noted above, when you put your children’s names on the deed to your home, you give them a legal interest in it. That comes with responsibilities and privileges. One of the privileges we mentioned above is that your child now has the legal right to encumber his/her interest. That means he can take out a loan and use his interest in your home as collateral.
It also means that if your children have unpaid debts, their creditors can use your home to collect on the debt. Your child may have credit card debt, unpaid loans, or may have liability from lawsuits or accidents. The point here is that if their name is on the deed to your home, you may end up paying for these debts with your home. Creditors can put a lien against your house, preventing you from selling or refinancing your home until that lien is paid off.
Medicaid’s look back
One reason older people add their children’s names to the deed on the family home is that they believe it will prevent Medicaid from taking the home to pay for nursing care. They think that by getting title to the home out of their names, Medicaid won’t know that they have a house that could be used to pay for their care.
But this is an ill-advised approach to providing long-term health care.
Medicaid has a 5-year “look back” procedure. This procedure, part of the Social Security Code, is used by the government to ascertain whether an individual has the resources to pay for his/her long-term care. Medicaid looks back 5 years before you apply for benefits to see whether you gave away assets like money or your home, which could have been used to pay for your care. If they find that you did this, you may pay penalties or lose your benefits.
The good new is there are several ways to avoid probate that DON’T involve putting your children’s names on your deed.
BENEFICIARY DEED
Arizona law allows a property owner to transfer property to a beneficiary through a beneficiary deed or what is sometimes referred to as a “transfer on death deed”. It is a deed which is recorded with the County Recorder that grants a residential property to a designated beneficiary upon the death of that individual. While living, the owner has complete control over their property and they can change or revoke the deed at any time. They can sell the property, which has the effect of revoking the beneficiary deed and the property avoids the probate process.
While a beneficiary deed is not as flexible as a living trust, it can be valuable and low cost tool to transfer property to specific beneficiaries.
Establishing A Trust
Another alternative to putting your house in your children’s name is establishing a trust. A trust is a legal arrangement where you transfer assets into the trust, and the children assume ownership of the trust property after your passing. This approach allows you to retain control over the assets while also providing a protective layer and keeping the tax consequences as low as possible. A Trust may be a better option for minor beneficiaries, property with joint owners and longer term planning needs.
Contact us to learn more about using a Beneficiary Deed or a Trust to pass property to your loved ones.