“I want to be good to my children, so I am adding them to the deed to the house.” We hear it in the office, on the radio show, in emails, and during phone calls, and it is almost always well-intentioned. Many times, however, what sounds like a nice idea is actually a detriment to the financial futures of both parents and children. An understanding of IRS rules can prevent costly errors from being made. Generally speaking, once the error has been made, there are no “do-overs.”
Owning a home presents the owner(s) with opportunity to commit an egregious (and common) financial planning error. Parents who add children’s names to the deed for the family home harbor a misconception that it will facilitate the title transfer upon the death of the last parent. In fact, it usually does the opposite, due to a tax rule called a “tax basis step-up,” or simply “stepped-up basis.”
The basis step-up is a simple, yet powerful, tax-saving concept. Inherited assets receive a basis step-up upon the death of the owner. This means that the assets are deemed to have “cost” the beneficiary whatever the market value of those assets is at the time of the owner’s death. As a result, those assets can be sold, and the only gain that needs to be reported is the difference in value between the stepped-up basis and the amount received from the actual sale. For long-held and/or highly-appreciated assets, this can mean thousands of dollars in tax savings as those assets are sold. Avoiding taxes is best accomplished by merely passing along the house to beneficiaries as instructed in a Will and/or Trust.
A further tax benefit is derived from the new (and much higher) exclusions from the “Death Tax.” Every person can now leave over $11 Million to his or her heirs, with absolutely no (Federal) inheritance taxes due. For most of us, this means simply that Death Taxes will not apply (I am assuming for now that the current tax law will be made permanent, as parts of it are set to expire in several years).
“Too nice” mistakes are not limited to treatment of a home. Gifting other assets, including money, can also catch unknowing parents in a tax trap. One of the most common mistakes involves gifting of appreciated stock. Assume that stock purchased for $1,000 is worth $10,000 today. Selling would create a $9,000 capital gain tax bill, and gifting the stock to the child for a later sale does the same thing. The only difference is that the new owner gets the tax bill. Should that same stock be inherited, the tax basis would be stepped-up to $10,000, and a subsequent sale world generate no tax bill. It pays to know the rules.
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