Should You Put Your House in Your Child’s Name?
One of the ways families build wealth across generations is through home ownership. Parents who can afford to give a property to children who either sell the home and distribute profits or keep it in the family have a definite advantage over generations of renters. How to transfer the home is not always straightforward. A recent article from The Washington Post titled “Don’t put your kids on the title of your home. There’s a better way for them to inherit the property” explains how to do this.
In this article, the mother placed an adult child on the deed to a home purchased some five years ago. The mom wants to sell the house and buy a smaller one nearby. The adult child has never lived in the home. The mother wants to do an 80/20 split of profits from the sale, with the child receiving the majority amount. This would push the child into a higher tax bracket, although the child says she could use the income.
The mother, despite her good will, has made a classic estate planning mistake by putting her house in her child’s name. Was she trying to avoid probate at death, or to give the child some or all of the property?
As the homeowner, the mother may exclude the first $250,000 in profits from federal income taxes, if she was the sole owner. If she were married, that number would be up to $500,000. However, she’s not the sole owner.
When a person dies, if the deceased person owned the house outright on in a special kind of trust, the heirs will inherit the real estate a “stepped up” basis, which is its current market value. If the home was purchased for $100,000 and its worth is $500,000 when the owner dies, a child who inherits the home outright and then sells it immediately will receive about $400,000 in profits, whcih will be classified as taxable capital gains. The tax liability on these capital gains of $400,000 could be as high as $104,000 ($400,000 X (20% federal capital gains tax rate + 6% Louisiana income tax rate). However, if the house was inherited after death (or through one of the aforementioned trusts) and then sold shortly thereafter, the IRS would say the property value is $500,000, resulting in $0 tax liability.
If someone inherits a home worth $500,000 and then sells it for $500,000, there is no profit because of the stepped-up value of the home assigned at the time of the owner’s death. In other words, $500,000 sale price minus $500,000 new “stepped up” basis at death = $0 tax liability.
Keep in mind that if the estate in total is worth less than $11.7 million, estate taxes are not a concern. Federal and state income taxes should be the primary concern.
Here’s the twist: if the mother and child are co-owners of the home and the mother dies, the child inherits only one-half the value of the home (and receives the stepped-up basis for the half but won’t benefit from the stepped-up basis). If the child sells the home, they won’t pay taxes on the share inherited from the mother but would pay taxes on the child’s share of the home.
If the mom bought the house for $100,000 and the mother and child are co-owners, the child would inherit the mother’s half of the property at the stepped-up basis of $500,000. When the home was sold, the mother’s half is shielded from taxes, but the child’s profit is calculated based on the difference between the purchase and sales price, or $400,000, of which their share is $200,000. They would owe taxes on the $200,000, instead of inheriting the home tax-free.
There are many estate planning and real estate tax rules making this more complicated. However, one better alternative is for the mom to put the home in a that special kind of trust, so she controls the home while she is alive, and the child can inherit the home through the trust upon her death. Talk with a qualified estate planning attorney that understands taxes about how to create a trust and how it would work to benefit both of you.
Keep in mind one other thing if the house is put in the child’s name: if the home is owned by the child that does not live in it, the home will not quailify for the $75,000 homstead property tax exemption, and any future freezes on property taxes will not apply, making this not just an income tax mistake by the parent, but also a property tax mistake as well.
Keep in mind one other thing. If your home is in your child’s name, your home generally would be even less asset protected from lawsuits. In other words, if your child is involved in a car accident, the person your child hit in the accident and his personal injury lawyer (even if that person was really not injured) can put your house (including other assets) up for grabs in the lawsuit. Don’t do that.
The bottom line is that you should almost never put your house in your child’s name.
To learn more about estate planning, read these articles: Can You believe Aging Parents Grow Stubborn and They Know It? and What Does Tax Proposal Mean for Estate Planning? and 12 Fatal Mistakes Taxpayers Make in an IRS Audit and What Is the Benefit of a Roth IRA at the Time of Retirement?
Reference: The Washington Post (Oct. 20, 2021) “Don’t put your kids on the title of your home. There’s a better way for them to inherit the property.”