We often meet with families who want to ensure their home can be protected during their lifetime and left to their children when they pass on. Unfortunately, there is a significant amount of confusion over the “right way” to complete this planning. Many people have been misled as to the type of planning they need. They mistakenly believe there are inexpensive, “easy” ways to plan. Based on misinformation they choose less expensive strategies now that often require costly, complicated solutions to fix later, if that is even an available option. Sometimes it is just too late to fix.
There are three such planning techniques we frequently see used that cost little up-front but carry a heavy burden for the family later on. They are:
- Transfer on death deeds
- Joint Ownership
- Life estate
Transfer on Death Deeds
The newest of these techniques in California is the transfer on death deed. What happens is that the owner of the real property creates a deed that adds the name of at least one additional person as a beneficiary of the property should the owner die.
This can be an appealing option to many people because, at first, it appears to be an easy transaction. By naming another person as a beneficiary the idea is that the property could be transferred at death without the need for an attorney, realtor or the probate court system. However, transfer on death deeds, can create more problems than they solve. If a deed is not recorded correctly or a beneficiary is not updated timely, then the home will be subjected to probate or transferred to an unintended person. Worse yet, if the homeowner is incapacitated there may not be a way in which a previous transfer on death deed can be changed. At least without court intervention or litigation.
For more detailed information about these types of deeds and the planning pitfalls, see our previous blog, “Quick Guide to California Transfer on Death Deeds,” which you can access by clicking this link.
The other two techniques, adding members to title or creating a life estate, have similar consequences although they are different in operation.
When a person wishes to add a family member (usually an adult child) as a joint owner, the basic idea is to create an immediate transfer of the entire property when they die to that child. Sometimes, the proposed solution is to just transfer the entire title of the home over now. If life pans out in exactly that order with no other complications, then such a technique scan be successful. However, life hardly goes according to our plan. If the adult child dies first, depending on how you transferred his or her interest to them, it may be part of that child’s estate and go through probate. If an adult child goes through a bankruptcy, divorce, or is subjected to a civil lawsuit, a forced sale of the home may ensue. Lastly, if an adult child becomes incapacitated, it may become extremely difficult to sell or mortgage the property, if needed.
With a life estate, a person transfers the interest in his or her home to another (usually an adult child) but retains the ability to live there during his or her lifetime. This creates a more certain succession of your home, unlike the transfer on death deed. It also allows the original homeowner to retain the benefits of living in the home or the income in produces if it is rented. At the same time, the transferee is not responsible or liable for mortgage payments, taxes, or general maintenance. This is often seen as an equitable relationship. In addition, the person retaining the life estate does not take on the liabilities of the future owner in the event of bankruptcy, divorce, or lawsuits. Similar to adding people to title through an outright deed transfer as discussed above, however, there are other distinct disadvantages and often unforeseen consequences to avoid.
First, transferring title (even in part) for a life estate is a reversible act without consent of all parties. If there is a change of circumstances or in the relationship, it would be nice to have the ease and flexibility to easily adjust. If all parties do not agree or are not legally able to consent, however, it may become impossible to do so. For example, if the home needs to be sold or mortgaged but the adult child who is deeded a life estate or brought on as a joint owner is incapacitated, it will be legally difficult or impossible to take this action absent court intervention or litigation.
Second, there are other tax concerns as well. When you add someone to your property as a joint owner, or create a life estate, you are giving up an interest in your property. This interest has a present value, which can be considered a gift for tax purposes if no money is exchanging hands, which it often does not when family is involved. This can have tax consequences to you, especially if the amount of interest gifted is higher than the annual federal tax exclusion amount for gifts (now $15,000). Given home values in California, even the smallest interest in property will easily fall above this amount.
Third, when you transfer real property or a portion of it to another outright or through a life estate you might negatively impact the ability to minimize capital gain taxes on the sale of the property. With a life estate, the Life Tenant will not be able to take full advantage of the normal personal exemptions ($250,000 per person, and $500,000 for a married couple) against capital gains.
Similarly, joint ownership affects the step-up in basis. When a person inherits property through death, he or she will receive a new tax basis in the property at the fair market value at the time of death. This can be a significantly favorable tax event. For example, if you purchase your real property for $100,000 but now it is worth $200,000, at your death your beneficiary will receive the base value of the property at $200,000. This means that if the property is sold at $200,000 there will not be a significant capital gains tax associated with the sale. By contrast, if your heir is a joint owner of your property, he or she will not receive a full step-up in basis and capital gains taxes will not be minimized to the full extent.
Lastly, transferring joint ownership and life estate deeds can cause significant complications for long-term care planning. This is a present interest gift. As such it can be a disqualifying, uncompensated transfer under the Medicaid eligibility rules (called Medi-Cal in California), leading to a period of time you are ineligible to receive money to help pay for the costs of care.
While at first glance, simple solutions to transfer real property may appear to be an easy choice, it is important to talk to your estate planning and elder law attorney along with your accountant before taking action. Be sure to discuss the long-range implications of this type of planning before making any decisions.
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Kevin Snyder is a husband, father, and an attorney at Snyder Law, PC in Irvine, California. He is all about family and has a passion for educating his community about trust and estate planning, veterans issues, and how to protect what matters most.