Estate Planning, Tax Planning

Why You Shouldn’t Add Your Heirs to Your Deed

No one likes planning for their own death, but when it comes to your wealth and taking care of your family, it’s a necessity. Over the last few months, I’ve had clients ask about putting their heir(s) on the deed of their properties. Additionally, I’ve learned some have followed through on this, not knowing the ramifications. In this article, I’ll cover some of the reasons why you shouldn’t put your heirs on your deed.

In a past article, I wrote about three common estate planning mistakes. This was one of those mistakes.

Why People Do It

First, while I’m going to make the case for why this can have harmful, unintended consequences, I understand why it happens and the thought process behind it. Generally, property owners want to avoid probate; they want the properties to pass to their heirs easily; and they know that if they can’t make decisions themselves, their heirs will be able to step in and assist them. These are just some of the reasons I’ve heard and all are valid and rational thoughts.

Before we get too far into this article, I want to say I am not an attorney and this article should not be taken as legal advice. You should consult an attorney before making any decisions. While I’m not an attorney, I know that, through proper estate planning, avoiding the issues mentioned here can occur without adding your heir(s) to the deed of your home.

The Pitfalls of Adding Your Heirs

There are three main reasons why I recommend that clients avoid this practice. The first is the loss of step-up basis their heirs receive. Next, the unintended and often-unreported tax ramifications. Lastly, the legal concerns of adding additional names to the deed.

Step-Up Basis

Keeping Your Heirs off The Deed Before Your Death

Let’s assume you purchased your home for $250,000. That purchase price becomes your basis. Fast forward to today, the home is now worth $600,000. If you sold your property today, you would have a realized gain of $350,000 ($600,000 – $250,000 = $350,000). 

Upon your death, your heirs would receive a step-up basis (or readjustment of the value of an appreciated asset for tax purposes upon inheritance) on the property. Instead of having a $350,000 realized gain, their basis would be the value of your home on your date of your death, or the alternate valuation date.

I won’t go into alternate valuation dates in this post, so let’s just assume your heirs own the home at the value at date of your death, $600,000. When they sell the home, either in the near term or when they decide to sell in the future, they will only pay taxes on the difference of the sale price and their basis of $600,000.

Putting Your Heirs On The Deed Before Your Death

Using the same example as above, you purchased your home for $250,000 and it’s now worth $600,000. This time, you decided to add your heir to the deed prior to your death. When you put your child on the deed, you technically made a gift of one-half the value of the property, $300,000. Your child would also receive one-half of the basis, $125,000. At your death, your child sells the home for $600,000. She would be liable for taxes on $175,000 of realized gain ($300,000 – $125,000 = $175,000). This tax could have easily been avoided with a little bit of education, a conversation with a financial planner, estate planning attorney, or a CPA prior to adding her to the deed.

Tax Ramifications

In the first example, I made the comment that you technically made a gift to your child by adding her to the deed. The IRS requires you to report this gift. Your home was worth $600,000.You deeded half to your daughter, so you gave her a gift of $300,000. While this may not be a problem federally, as the 2019 lifetime gift exclusion is over $11 million, it does need to be reported since the amount exceeds $15,000 – the maximum amount of a gift given in a single year that doesn’t need to be reported. You may avoid having to pay a gift tax because of the lifetime exclusion, but there are penalties for not filing a gift tax return when required.

Our tax code is complicated, and willful neglect is not a reasonable excuse for not filing. Your best bet is to seek the guidance of a tax professional who can guide you through the ins and outs of your specific needs. 

Legal Concerns

Divorce –The courts will do their best to divide property in an equitable way. If you deeded a portion of your home to your heir, her former spouse may be entitled to a share of your home. With somewhere between 40-50% of all marriages ending in divorce, it doesn’t seem worth the risk of adding her to the deed.

Creditors — When creditors are involved, your heir’s problems become yours. If she has issues with creditors, her share of the property is subject to creditor claims, including credit card companies and lending companies as well as liability claims from accidents.

Bankruptcy — More than three-quarters of a million people filed for bankruptcy in 2018. If the heir on your deed files for bankruptcy, the courts may be entitled to their portion of the home to satisfy their debts.

Even the best-intentioned actions can often lead to severe, unintended consequences, like increased tax bills and losing your home to creditors. I discuss all of these topics when people say to me, “can’t I go online and create my own estate plan?” Sure, you can absolutely use an online service. However, an online service is not going to tell you not to deed your property to your daughter because she has creditor issues, because she is on the verge of a divorce, or because of the loss of full step-up basis. It’s important to discuss your individual situation with a tax professional who will help you make the right decision.