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. 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, heirs inherit real estate at 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. If the house was inherited after death and then sold shortly thereafter, the IRS would say the property value is $500,000.

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. However, if the estate in total is worth less than $11.7 million, estate taxes are not a 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 living 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 an estate planning attorney about how to create a living trust and how it would work to benefit both of you.

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.”

Does Your Estate Have to Go Through Probate?

Probate is a court-supervised process intended to ensure the validity of a lasts will and to protect the distribution of assets after a person has died. If there is no last will, probate still takes place, according to the article “Probate—Courts protecting you after death” from Pauls Valley Democrat.

Every estate that owns property must be probated, unless the title or ownership of the property has been transferred before the person died by gift, if the property is owned jointly with another person, or if it passes by direct beneficiary designation. If a person died without a last will, probate still takes place, but the guidelines used are those of the state law where the person died.

In all cases, it’s better to have a last will and to decide for yourself how you want your assets distributed. For all you know, your state law may give everything you own to an estranged third cousin and her children, who are perfect strangers to you.

If you don’t have a last will, which is referred to as dying “intestate,” the court decides who is going to serve as your administrator. This person will be in charge of distributing all of your worldly goods and taking care of the business part of settling your estate, like paying taxes, selling your home, etc. Without a last will, the court picks a person, and it might not be the person you would have wanted.

Here are the basic steps in probating an estate, once the probate petition is filed:

Initial hearing. This is where the court affirms its jurisdiction and identifies all known heirs, and the personal representative is identified.

Letters Testamentary. This document is issued to the personal representative. This is a judge signed document proving to others, like banks and investment custodians, that the personal representative is legally permitted to handle your property and act on behalf of your estate. It’s similar to a Power of Attorney.

Probate. This court process collects, identifies, and accounts for all assets of a decedent. The representative must be mindful to document any money going in and out of the estate during the administrative process.

Written notice must be given to all and any known heirs. This can lead to relatives and others believing they have a claim on your estate and to then challenge the provisions of your last will with the court.

Notice is also provided to creditors, who have at least 60 days after notice is provided to make a claim on the estate. This timeframe varies by jurisdiction. In some jurisdictions, these notices are published in local newspapers, once a week for two or more consecutive weeks. Once they receive fair notice, general creditors who fail to file a claim lose their right to ever file a claim on the estate.

An estate plan is created with an eye to minimizing taxes, maximizing privacy for the family and heirs, and transferring ownership of assets with as little red tape as possible. Failing to properly plan can lead to a probate taking months, and in some cases, years.

Reference: Pauls Valley Democrat (July 1, 2021) “Probate—Courts protecting you after death”

What Is Family Business Succession Planning?

Many family-owned businesses have had to scramble to maintain ownership, when owners or heirs were struck by COVID-19. Lacking a succession plan may have led to disastrous results, or at best, less than optimal corporate structures and large tax bills. This difficult lesson is a wake-up call, says the article “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’” from Bloomberg Tax.

Another factor putting family-owned businesses at risk is divorce. Contemplating the best way to transfer ownership to the next generation requires a candid examination of family dynamics and acknowledgment of outsiders (i.e., in-laws) and the possibility of divorce.

Before documents can be created, a number of issues need to be discussed:

Transfer timing. When will the ownership of the business transfer to the next generation? There are some who use life-events as prompts: births, marriages and/or the death of the owners.

How will the transfer take place? Corporate structures and estate planning tools provide many options limited only by the tax liabilities and wishes of the family. Be wary, since each decision for the structure may have unintended consequences. Short and long-term strategic planning is needed.

To whom will the business be transferred? Who will receive an ownership interest and what will be the rights of ownership? Will there be different levels of ownership, and will those levels depend upon the level of activity in the business? Will percentages be used, or shares, or another form?

In drafting a succession plan, it is wise to assume that the future owners will either marry or divorce—perhaps multiple times. The succession plan should address these issues to prevent an ex-spouse from becoming a shareholder, whose interest in the business needs to be bought out.

The operating agreement/partnership agreement should require all future owners to enter into a prenuptial agreement before marriage specifically excluding their interest in the family business from being distributed, valued, or deemed marital property subject to distribution, if there is a divorce.

An owner may even exact a penalty for a subsequent owner who fails to enter into a prenup prior to a marriage. The same corporate document should specifically bar an owner’s spouse from receiving an ownership interest under any circumstance.

A prenup is intended to remove the future value of the owner’s interest from the marital asset pool. This typically requires the owner to buy-out the future spouse’s legal claim to future value. This could be a costly issue, since the value of the future ownership interest cannot be predicted at the time of the marriage.

Many different strategies can be used to develop a succession plan that ideally works alongside the business owner’s estate plan. These are used to ensure that the business remains in the family and the family interests are protected.

Reference: Bloomberg Tax (April 5,2021) “Succession Planning for the Family-Owned Business—Keepin’ it ‘All in the Family’”