How to Benefit from an Estate Plan When You Own Real Estate

Introduction

Many parents believe that by adding a child’s name to a property deed, they can pass along the property outside of probate. Unfortunately, those who act on that belief often find they have invited more problems than they have avoided. Estate planning, particularly when it involves real estate, is a complex process that requires careful consideration to avoid pitfalls such as probate complications and adverse tax consequences. This guide will explore various aspects of estate planning for real estate owners, providing insights into ownership types, legal implications, tax consequences, and effective strategies to safeguard your property and legacy.

Understanding Property Ownership Types

Tenants in Common

When more than one person owns property together and they are not married, the property is often held as tenants in common. This type of ownership means that each owner has an individual, divisible interest in the property. If one owner dies, their share of the property does not automatically transfer to the surviving owners but goes to the deceased owner’s heirs through probate. This can lead to unwanted complications and delays.

Joint Tenants with Right of Survivorship

An alternative to tenants in common is joint tenancy with the right of survivorship. This arrangement means that if one owner dies, their share of the property automatically transfers to the surviving owners, bypassing probate. This designation must be explicitly stated in the deed to ensure that the property is handled according to the owners’ wishes. Seeking legal advice to set up this type of ownership can help prevent probate and ensure a smoother transition of property ownership.

Legal Implications of Adding a Child to a Deed

Probate Complications

Adding a child’s name to a property deed with the intent to avoid probate can inadvertently cause more problems. If the deed does not explicitly state joint tenancy with right of survivorship, the property will still go through probate upon the death of one owner. This process can be time-consuming and costly, defeating the original purpose of avoiding probate.

Medicaid and Medicare Considerations

Adding a child’s name to a property deed with the intent to avoid probate can inadvertently cause more problems. If the deed does not explicitly state joint tenancy with right of survivorship, the property will still go through probate upon the death of one owner. This process can be time-consuming and costly, defeating the original purpose of avoiding probate.

Tax Consequences of Transferring Real Estate

Gift Tax Implications

When real estate is transferred as a gift by adding a child’s name to the deed, it is subject to gift tax rules. The IRS considers this a taxable event, and the original cost basis of the property (what you paid for it) transfers to the new owner. This can result in significant capital gains tax when the property is eventually sold.

Example Scenario:

Consider a home purchased for $50,000 that is now worth $350,000. If you add your children to the deed and they sell the home after your death, they will be taxed on the difference between the original cost basis ($50,000) and the sale price ($350,000), resulting in a taxable gain of $300,000. This substantial tax burden can be avoided with proper estate planning.



Inherited Property and Step-Up in Basis

If your children inherit the property through a will instead, they benefit from a step-up in basis. This means the property’s value at the time of inheritance becomes the new cost basis. Using the same example, if the property is worth $350,000 at the time of inheritance, and the children sell it for that amount, there will be no taxable gain. This strategy can significantly reduce the tax burden on your heirs.

Effective Estate Planning Strategies

Creating a Trust

One of the most effective ways to avoid probate and minimize taxes is to create a trust. By transferring real estate into a trust and naming your children as beneficiaries, you can ensure the property passes outside of probate in a tax-advantaged way. Trusts offer flexibility and control over how and when your assets are distributed, providing peace of mind and protection for your heirs.

Consulting with an Estate Planning Attorney

Given the complexities of estate planning, it is advisable to consult with an experienced estate planning attorney. They can help you navigate the various legal and tax implications, ensuring your estate plan aligns with your goals and protects your assets. An attorney can also coordinate with financial advisors and tax professionals to create a comprehensive plan that meets all your needs.

Addressing Government Benefits Concerns

For those concerned about the potential impact of Medicaid or Medicare on their property, specialized estate planning strategies are available. An attorney can help structure your estate to protect your home from being taken to cover medical bills. This might include setting up irrevocable trusts or other legal mechanisms designed to shield your assets while still qualifying for benefits.

Conclusion

Effective estate planning is crucial for real estate owners who want to avoid probate, minimize taxes, and protect their property from potential government claims. By understanding the different types of property ownership, the legal implications of adding a child to a deed, and the tax consequences of transferring real estate, you can make informed decisions that benefit your heirs and preserve your legacy. Consulting with an estate planning attorney and utilizing tools such as trusts can provide additional security and peace of mind.