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Think Twice Before Transferring Your Home to Adult Children

On Behalf of | Aug 17, 2020 | Estate Planning, Probate, Taxes and Finances |

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 pass, 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.

However, if you wait to leave your house to your kids when you die, the benefits are much greater. That is because your children 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 may only work 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 may be penalized and their ability to receive Medicaid may be more complicated than necessary.

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, though it would transfer outside probate.

A “life interest with powers” 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. There is a significant difference if the gift is made with a “life interest with powers” or a “life interest without powers.” This should be carefully discussed with your estate planning attorney.

If your goal is to avoid probate, there is something called a “life interest” or “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.  This does not protect the home from creditors and is not a tool for Medicaid planning, however, it is a good option for many people.

Please speak with your estate planning attorney prior to endorsing any of the documents mentioned in this article.