Sometimes, people try to avoid paying attorney fees by using alternative estate planning methods. By alternative, I mean doing something other than creating a trust or will to pass assets on to their children. Some alternative estate planning methods are perfectly legitimate and advisable, such as Transfer on Death designations with your bank or IRA custodian, or beneficiary designations on your life insurance.
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The legal mechanism for passing assets in these examples is “by operation of law,” that is, they pass by operation of law outside of probate, and the right to the asset vests immediately upon the occurrence of a specified event. Passing assets by operation of law is an attractive idea. You don’t have to hire an attorney, and your kids don’t have to go to court. You can even transfer a house to someone by operation of law through joint tenancy (i.e. joint ownership) with the right of survivorship.
But putting your child on the deed to your home as a joint owner opens you up to a world of unintended consequences.
Here’s how joint tenancy with the right of survivorship works. Imagine there’s a pie that is jointly owned by three people. Now one joint owner dies. Instead of the pie being split three ways, the pie is now split two ways. The other two joint owners split the deceased person’s share of the pie via the right of survivorship. If a second joint owner dies, and there’s only one joint owner left, well that remaining joint owner now owns the whole pie. (By the way, joint ownership of a bank account can work the same way, if you make sure the right of survivorship is included) All of this happens by operation of law – no court necessary.
Sounds great, right? Well here’s the rub. You shouldn’t put your child on the deed to your house as a joint owner because 1) taxes and 2) creditors. Both are boogeymen I fight to avoid whenever possible, and you should too.
A child who inherits real estate by joint tenancy is going to have an extra high tax bill because they won’t receive the step-up in basis they otherwise would. Normally, when property passes by will or intestacy, all of the unrealized gain that is represented by the difference between the purchase price of the house (the basis) and the market value of the house at the time of the death, passes free of the capital gains tax rate. The inheritor receives a “step up in basis,” and the capital gains tax equation is reset to the market value of the asset. If they receive it by joint tenancy, they inherit the original purchaser’s basis in the house, and the accompanying tax bill.
Here’s some example math on that. Say you buy the house for $500,000, and it’s worth $1 million at the time of your death. If you sold it just before your death for the market value, the taxable gain would be $500 thousand, less the $250,000 personal residence exemption amount. So $250,000 is taxable at the 23.8% capital gains tax rate, for a tax bill of $59,500.
But if you pass it to your kids by trust, will or intestacy, then your child avoids paying the $59,500 tax bill and inherits the asset at the market value of $1 million, and will only have to pay the tax bill for any future appreciation. If instead you do some alternative estate planning and put your child on the deed as a joint owner, they inherit your $500,000 basis in the house, and will have to pay the $59,500 plus whatever tax would be due from future appreciation of the asset. Rough math, huh?
Now, here’s how you get a creditor problem when you put your child on the deed to your house. If you put your child on the deed to your house, it becomes a matter of public record when the deed is recorded with the county. If your child ever got into debt trouble, or became a debtor in, say, a personal injury lawsuit, their creditors could attach a lien to their interest in your house and even become part owners if they are successful in their lawsuit. Ouch!!
In sum, do yourself and your kids a favor by putting together a will or revocable trust to pass your assets to them. You’ll save them a world of time, trouble, and money. Maybe now you get why I say all the time, estate planning is an act of care and compassion towards the ones you love!
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Misha is an estate planning attorney at Speedwell Law, PLLC. If you would like assistance in setting up your own estate plan, he can be reached at (703) 553-2577 or email@example.com.
This post, including any of its contents or links, is not intended to provide you with legal advice. It provides personal perspectives on legal news and developments. Reading this post, leaving a comment, or communicating with its author by email or over the Internet does not create any attorney-client relationship.