Many clients ask about adding a family member's name to the deed for their home or other real estate - or transferring the property outright before passing away. Alternatively, many clients may have already done something like this before seeking advice from an attorney.
Typically, the thinking behind this is something along the lines of:
a. I want to transfer the house to my children now so they don't have to go through probate.
b. If add my child as a joint owner of the house now, with right of survivorship, then the house will automatically transfer to them when I die - without the need for probate.
c. If I transfer the house to a child now, then I can qualify for Medicaid down the road later.
But let's examine why, in each of these cases, transferring ownership in the home like this is not the best approach to planning your estate.
Chances Are You May Not Be Handling Gift Taxes Correctly
As a general principle, many clients approach these transactions as simply "putting someone's name on a deed." This is sort of a 'now you own it - now you don't' approach. But let's take a second and think more closely about what is happening when someone 'puts their name' on a deed.
What is really happening is that you are transferring an asset (or at least part of one), and one that is typically quite valuable - likely worth hundreds of thousands of dollars. Any time large amounts of money change hands like this, everyone's favorite family member tends to take notice: Uncle Sam.
Often these transfers are made as gifts. And while no tax may necessarily be owed on the transfer, transfers above the annual exclusion amount must be reported on IRS Form 709 because the value of the transfer must be counted toward your lifetime gift and estate exclusion amount.
At this point you may be asking yourself, "Yeah, but does the IRS really find out about these things?" The answer to that question would be: yes. As this December 18, 2011 article in Forbes magazine, titled "Federal Judge Green Lights IRS Search For California Gift Tax Cheats" notes:
A federal district court judge has given the Internal Revenue Service permission to serve a “John Doe” summons on the California State Board of Equalization demanding the names of residents who transferred property to their children or grandchildren for little or no money, from 2005 to 2010. The IRS wants those names as part of a crackdown on what it believes is the widespread failure to file required tax returns when real property is passed between family members.
The IRS has already received information about intra-family property transfers from county or state officials in Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia (emphasis added), Washington state and Wisconsin. But officials of California’s BOE said state law prohibited them from disclosing the information without a court approved summons.
Gift Tax Is Not The Only Concern - Don't Forget About Capital Gains
Additionally, if you are transferring a home before your death - as opposed to the recipient inheriting the home at your passing - your heir can miss out on favorable tax treatment of capital gains known as a "step up in basis."
Step up in basis is essentially a rule where the IRS allows capital gains on the sale of inherited assets to be calculated using the value on the date of death of the owner - rather than the purchase price. This way, the amount of capital gains subject to tax is lower, so less tax is owed when the asset is sold.
However, this rule applies to assets that are inherited. As a result, making a transfer of an asset during your life would likely mean that the asset would not be considered to be inherited and this favorable tax treatment is lost.
Titling real estate as joint owners with right of survivorship will avoid probate. However there are ways to avoid probate without losing the preferential tax treatment associated with inherited assets. This would include methods like use of a trust, for example a revocable living trust. Additionally, keep in mind that probate is not always unduly complicated.
Older clients may transfer real estate to family members because they are thinking they might want to qualify for Medicaid at some point in the future. But remember, Medicaid has a five year "look back" period where uncompensated transfers can result in qualification penalties. Additionally, Medicaid has provisions that would allow a home to be considered a non-countable resource for qualification in some circumstances, make such a transfer potentially unnecessary.