Your Home, Your Estate
Published On: April 24, 2018
Written by: Ben Atwater and Matt Malick
A major asset for most mass affluent families is a home. As such, your home or homes are also important components
For a married couple, your home is generally titled jointly and at the death of the first spouse the home passes to the surviving spouse. For tax purposes, half of your home gets a step-up in basis (you use the deceased spouse’s date of death value for their 50% share of the home) applied to a future sale. There are no current tax consequences for the surviving spouse who now owns 100% of the home.
Should you add your children to the title of your home?
After the death of a spouse, clients sometimes ask if they should add children to the title of their home. Although this technique sounds like a common-sense way to protect your equity from potential long-term care expenses while facilitating the transfer of your home to your heirs at death, it is fraught with potential issues.
Although not normally taxable, any transfer of interest in your home is considered a gift and you would need to file a gift tax return. Despite this technicality, you would very likely owe no tax as a result of the gift (an individual’s lifetime gifting exemption is currently $11.2 million), making this requirement a minor hassle.
A gift of an interest in your home passes your cost basis to your children. This contrasts with selling your house at death when your house would get a step-up in basis as of your date of death, therefore eliminating capital gains.
Although such a transfer can protect assets from long-term care costs, there is a five-year lookback period for Medicaid. The ironic shortcoming of this as a Medicaid strategy is that you could actually need your house in order to qualify for a “nice” facility should you ever require long-term care.
If for any reason your children were to get sued, divorced or otherwise run into a problem that involves liability, your home could also be subject to a lien or judgement. Furthermore, if one of your children were to predecease you, then your child’s will would control what happens to their share of your home, which could get complicated depending on individual circumstances.
As you can see, adding your children to your title is likely not the best idea.
What other options are there?
There are other ways to avoid probate such as placing your home in a trust. If you place your home in a living trust it’s important for your trust to retain the title to all of your assets or to make sure that the beneficiaries of the trust are the same as the beneficiaries of your larger estate. Homes are illiquid assets and require your trust or estate to cover upkeep, property taxes, transaction costs, commissions, maintenance, renovations, clean-up, mortgage payments, etc. after your death. Having ample liquidity in your trust or having the same beneficiaries of your larger estate helps avoid disagreements over how your trust or estate covers these costs after your death.
Most often clients simply pass a home to heirs through the normal probate process. And many mass affluent people today no longer own homes at death because they transitioned into a continuing care retirement community. When selling your home, current tax law allows you to exclude $500,000 of capital gains from the sale of a home provided you have lived there for 2 of the previous 5 years.
What about your second home?
If you have a second home in a different state, you should consider titling it in a trust or in a limited liability company (LLC) to avoid ancillary probate. It’s preferable to circumvent probate in multiple states.
An LLC is useful if you rent your second home. This helps protect you against liability should something go wrong at your rental. However, using an LLC will prevent you from obtaining a traditional home loan.
Vacation homes come with other issues as well. Longtime vacation homes tend to be nostalgic and emotional family assets that children may or may not want to keep. Keeping a vacation home in the family turns siblings and in-laws into business partners – an arrangement that sounds good in theory but often fails in practice. Decisions about splitting time, upgrades, rentals, decorating, division of labor, etc. often become contentious.
The moral of the story
Your home is one of many potentially complex issues that your executors deal with at your death. The more thought, planning and communicating you can do today, the easier things will go in the future. We cannot overemphasize the importance of family communication in estate planning. It’s much better to have no surprises.
Please visit www.atwatermalick.com/ria for full disclosure materials related to recommendations contained in this update.
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