Joint Ownership to Avoid Probate

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Joint Ownership to Avoid Probate

I recently had two different clients ask me why they should use a trust to transfer real estate to their children when they could just add a responsible child to the title of the real estate.  The thought was that this would be a cheaper way of estate planning than paying for a trust to hold the real estate and would still avoid the court probate process for transferring property to their child or children.

While this strategy may effectively avoid probate, there are a few different reasons why it is not typically recommended.

  1. Tax Considerations

Loss of Step-Up in Basis: When a home is sold, the owner is responsible for paying capital gains taxes.  Capital gains tax is typically owed on the appreciation between the original purchase price (the “basis”) and the sales price.  The capital gains tax in 2022 is currently 15% for most people.  For example, if you purchased your home for $100K and then sell it 20 years later for $400K, you will owe capital gains tax on the $300K appreciation on your home, or $45K.  However, when you pass real estate to your heirs there is a “step-up” in basis at the time of death.  The basis for your heirs is adjusted to the value of the home at the time of death.  So if you purchase your home for that same $100K and when you die it’s worth $400K, your heirs won’t owe capital gains tax if they sell it right away.  This step-up in basis is lost if you transfer ownership to your child during your lifetime.  When your child goes to sell the property, the original basis would be used and capital gains tax would be owed on the entire appreciation from the time of purchase.

Gift Tax: In addition to the loss of the step-up in basis, there may be gift tax consequences.  In 2022, the annual gift tax exclusion is $16,000, and any gifts over this amount might be subject to gift tax. This is only a consideration, however, where the lifetime exclusion amount could be exceeded.  Currently, the life time exclusion is $12 million and change, so this is not an issue for most tax payers. However, the higher limit is set to expire in 2025.  If the higher limits are not renewed by Congress, then gift tax could become a consideration for many more people in this situation.

  1. Other Considerations

Joint ownership transfers the ownership interest immediately.  If the child has a judgement entered against him or her, then that ownership interest could be put at risk.  Additionally, there is no guarantee that the child will follow the wishes of the parents after they are gone.  Other siblings would not be able to enforce the wishes of the parents in court if the property is in the name of only one child.

On balance, transferring real estate into joint ownership with a child is usually not a good idea. The tax consequences can be costly, and there is no guarantee that your wishes will be fulfilled.  If you are interested in discussion your options for transferring property to the next generation, please don’t hesitate to contact us for a free consultation.

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