21 Aug Should You Put Your Kids on Your Deed?

Trent and Ella were in their late 60s and decided to put their son, Miles, on the deed of their home. They’d paid $500,000 for the property 30 years ago, and it was now worth $1,400,000. They figured that adding their son to their deed with them was doing him a favor by avoiding probate and making sure the house would easily pass to him when they were gone.

Years later, Trent and Ella passed away, and Miles inherited the house. When he decided to sell it, he was shocked by a hefty tax bill.  Miles was required to pay a substantial capital gains tax.   By the time he sold it, the property was worth $1,600,000. This left Miles with a capital gain of $1.1 million dollars, which meant a hefty tax bill. What Trent and Ella had intended as a generous gift turned into a financial burden for their son.

A Smart and Simple Solution?

For many, the family home is the crown jewel of their estate—a symbol of all they’ve worked for. In an effort to avoid the complications of probate, some well-meaning parents make the decision to add their children to the deed of their home. The thinking goes like this: “When I pass away, the house will automatically go to my kids without the hassle of probate.” While this strategy may seem like a smart, simple solution, it can actually backfire in a big way—especially when it comes to taxes.

The Tempting but Dangerous “Quick Fix”

Adding your kids to the deed of your home might sound like an easy way to ensure that they inherit the property without the delay and expense of probate. It’s quick, and it feels straightforward: if their name is on the deed, the house passes to them automatically when you die.

But here’s the catch: what your family saves in probate costs now, they’ll likely end up paying many times over in taxes later. The reason lies in something called the tax basis.

What is Tax Basis and Why Does It Matter?

The tax basis is essentially the value that’s used to determine how much profit you’ve made when you sell an asset.  This profit, in turn, determines how much tax you owe.

When you buy a property, the tax basis is usually the amount you paid for it, plus any improvements you’ve made. So, if you bought your home for $600,000 and put in $200,000 of improvements, your tax basis is $800,000. If you sell the house for $1,200,000, you have a gain of $400,000, which is subject to capital gains tax.

Here’s where it gets tricky: when you transfer your property by adding your kids to the deed, they inherit your basis—which is the same basis you had when you owned the property. In our example, that is $800,000.

The Nasty Surprise: Capital Gains Tax

Let’s say you pass away, and your children inherit the home via the deed. When they go to sell it years later, the property might be worth much more—perhaps $2,000,000. But because they inherited your original tax basis of $800,000, they now face capital gains taxes on the $1.2 million difference. Depending on the tax rates at the time, this could be a very substantial tax bill.

A Better Solution: The Stepped-Up Basis and Trusts

There is a smarter way to ensure that your children inherit your home without the pain of a massive tax bill and probate: use a trust. By placing your home in a properly structured trust, you can avoid probate while also taking advantage of the stepped-up basis.

With a stepped-up basis, the tax basis of the property is “stepped up” to its fair market value at the time of your death. If, for example, the property was worth $1,800,000 when Miles inherited it, that would be his new tax basis. If he sold the home immediately for $1,800,000, there would be no capital gains tax to pay.

Take Action

As we’ve talked about in previous articles, avoiding probate can save your family significant costs, frustration, and delay.  While that’s a worthwhile goal, trying to accomplish this in what seems like the easy way of using a deed alone has potential tax consequences that could cost your children dearly. To truly protect your legacy and ensure that your hard-earned assets benefit your family as you intend, it’s crucial to plan properly.

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