Dear Clients and Friends,
Think twice before transferring your home to adult children.
Your home might well be your biggest asset. Many times, parents think about giving their home to their adult children outright while the parents are still alive, or adding their names to the deed.
While doing so might avoid probate when you die, it’s also likely to lead to significant gift tax consequences. And if anything happens that could affect your kids’ assets, such as a bankruptcy filing or a lawsuit, your home could suddenly be in jeopardy.
But if you wait to leave your house to your kids when you die, the benefits are much greater. That is because your kids get a “step-up in basis” when they inherit the house, which means that the amount that your house increased in value while you were alive won’t be taxable when you die.
Parents also sometimes attempt to transfer a home to their children in an attempt to qualify for Medicaid. However, that only works if you do it more than five years before the parents need to use the benefits. Otherwise, the person or people who transferred the home are barred from receiving Medicaid.
It’s important to realize that gifting your home to someone can open you up to their financial issues. That means their creditors could file liens against your home and land. If your son or daughter gets a divorce, the value of your house could be divided as part of their case.
However, even if someone does transfer a home during his or her lifetime, there is a creative way to potentially get around paying a high tax bill on the gain in value. Under section 2036 of the Internal Revenue Code, if a taxpayer retained a “life interest” in the property, including the right to continue to reside there, then it wouldn’t be considered a “completed gift” and instead would remain in his or her estate.
A “life interest” is defined as having the power to decide what happens to the property and maintaining liability for its bills. To prove this, it helps if the adult child makes clear that he or she was gifted a “remainder interest” in the property to inherit the house after the parent dies.
If your goal is to avoid probate, there is something called a “transfer on death” deed allowed in many states that permits someone to leave their house to a beneficiary without probate.
You can also create a living trust, where your home and other assets are placed in the trust while you are alive and then transferred to your beneficiaries when you die.
We continue to invite you to call us for a free phone evaluation of your estate planning needs.