Most middle school students know the “I before E except after C” spelling rule. Of course, a lot of people know a lot of rules that should not be applied to every situation. You may have heard the “rule” that parents should add a child to the parents’ property to avoid probate upon the parents’ death. But before you run to google to find a quitclaim deed, please consider the following situation. Imagine that Adam and Barbara have one son, Chris, and are considering adding him to the deed of their $300,000 single-family home.
Loss of “stepped-up” basis
When someone inherits an asset (as opposed to being put on the deed), the cost basis of the asset is “stepped up to value” on the date of death. So what does this mean for Chris? If Chris were to inherit the property, his basis in the property for tax purposes would be the fair market value, $300,000, as of the date of his final parent’s death. Since Chris received a step-up in basis, if he later sells the home for $350,000, only the $50,000 is considered a gain as it represents the increase in value after his parents passed away. If instead he had been added to the deed prior to Adam and Barbara passing, his basis in the property would be the same as it was for his parents when they purchased the property. If Adam and Barbara had originally bought the home at a $100,000 value, Chris’s taxable gain when selling the home for $350,000 would be $250,000.
Federal gift tax
If Adam and Barbara were to add Chris to the deed, they have given him a taxable gift under federal gift tax law. If the value of the gift exceeds $14,000, it must be reported on a Gift Tax Return (IRS Form 709). For taxable gifts, each individual has total lifetime exemption before any out-of-pocket gift tax is due. In other words, under current law you can give away up to $5.45 million during your lifetime—over and above the annual $14,000 exclusion and any payments made directly to educational or medical providers on someone else’s behalf—and still avoid gift tax. But, the $5.45 million exemption applies to gift and estate taxes combined—whatever exemption you use for gifting will reduce the amount you can use for the estate tax.
Chris’s creditors access to the property
Once Chris is added to the deed, the property is Chris’s asset and subject to creditors’ collection. This means if Chris hits a financial bump in the road while his parents are still alive, they could lose their home.
Loss of parental control of the property
Once Adam and Barbara add Chris to the deed, he cannot be removed without his consent or subject to a court order. Adam and Barbara cannot sell or refinance the property without Chris’s consent.
Proper estate plans are as unique as the people themselves. There are few one-size-fits-all solutions. Let’s come back to our spelling rules to sum things up – with a clear conscience I can state I would rather be stranded in a beige room next to a freight elevator in a foreign, sovereign society than feign adherence to or in any way deify the heinous idea that all parents should forfeit control and jointly own property with their weird heirs simply to avoid probate. Call Alles Law in Grand Rapids today for help with proper estate planning.