Relaxing, you sip on a refreshing glass of iced tea, taking in the sights and sounds of summer and looking forward to your daughter coming home for a visit. You can barely contain your excitement, as you are going to surprise her by transferring your house deed to her name! The thought of saving your daughter the hassles and expense of probate brings the kind of relief that a cool summer breeze does on a stifling summer afternoon.But are those refreshing breezes you’re feeling or the stirrings of a tornado heading your way? Diana Ross and The Supremes may have said it best- Stop! In the name of love! Before signing on the dotted line, it’s important to understand the tax consequences of transferring your house deed to your child.
While it may seem like you are saving your child from the struggles of probate and estate tax, a whole new crop of tax conundrums will take their place. In essence, you are gifting yourself and your child a Pandora’s box of potential tax, liability, and equity issues. Below are a few of the consequences of transferring your house deed to your child.
- Your home is no longer your castle, as it now belongs to your child. If at some time in the future you want to take equity out of your home to cover an emergency medical expense, complete some home improvements, or even to take a cruise to Alaska, that will not be possible. You can also no longer obtain a reverse mortgage, which may be a good option to supplement your income in your twilight years.
- Although you may have an excellent relationship with your child now, no one knows what the future will hold. Since your child is now the homeowner, they can potentially force you to move out if they fall into financial hardship and need to sell the home to cover their expenses. They can also force you to move if your relationship sours.
- The home is now “fair game” to your child’s creditors and possible future ex-spouses. If your child is currently in debt, becomes indebted in the future or is even sued, creditors can potentially place a lien on the property and even force a sale through court proceedings to satisfy a debt. Additionally, if your child goes through a divorce after you transfer your house deed to them, their former spouse may make a claim for all or a share of the property.
- By transferring the title now, your child will not get the benefit of a step-up in the basis of the home. When you transfer the home to the name of your child, you are also transferring your cost basis (the amount you originally paid for the home plus the cost of any substantial home improvements). If the home title was still in your name or even put into a living trust, then the value of the home when your child receives it will be its fair market value on the date you pass away.
- Your child has the potential of owing the Tax Man a lot more money. Since your child will not receive a step-up in basis, they may end up paying tens of thousands of dollars in capital gains taxes. To illustrate the potential tax impact, say you purchased your home in California in 1975 for $80,000. You made some home improvements through the years totaling another $50,000. This gives you a basis of $130,000. On the date you pass away, the home is now appraised at $530,000. A few months after your passing, your child decides to sell the home and receives a purchase price of $530,000. After selling expenses of $25,000, your child has the potential of paying capital gains tax on approximately $375,000. If the home was still in your name or in the name of a living trust, your child would pay no capital gains tax and even have a capital loss that could be used to offset other potential capital gains. They may be able to use the home sale exclusion to help soften the capital gains tax blow if they live in the home as their primary place of residence for at least two out of the prior 5 years before they sell it. Generally, taxpayers may exclude up to $250,000 of gain on the sale of a primary residence if they meet the qualifications. The exclusion would help reduce the capital gain, but it may not erase it altogether.
- And then there’s the gift tax. Anytime you gift a person an amount over the annual gift exclusion (for 2019 that amount is $15,000), Uncle Sam requires the gift giver to file a gift tax return. Currently, a person can gift up to $11,180,000 worth of assets before having to pay tax on those gifts. This amount, called the lifetime gift tax exemption, is combined with the estate tax exclusion amount. So, if your total lifetime gifts and the value of your estate is more than $11,180,000, you will owe tax on the deed transfer. Even if your total assets and lifetime gifts are much less than $11,180,000, you are still required to file the gift tax return.
There are other alternatives than to transfer your house deed to your child. One alternative is to create a living trust. Another alternative which some states have implemented is the use of revocable transfer-on-death deeds, also known as a “TOD deed.” These deeds allow you to name a person who will automatically receive title to your home upon your passing. Many states who have TOD deeds allow you to change or revoke the person you’ve named at any time before your passing. You will need to find out if this option is available in the state where your home resides.
Remember, don’t stop thinking about tomorrow! A little careful and informed planning now will bring you and your child peace of mind and security down the road.