An extremely common mistake people make with regard to estate planning is the assumption that you can avoid estate taxes and probate simply by retitling your property in the name of your children or loved ones – i.e., giving it away. Or, if you don’t want to give the property away, the idea of adding children as joint tenants or even adding them as joint bank account holders seems like it could solve the problem.
Don’t give your property away during your lifetime
Let’s clear this up. It’s inevitable that at some point your property will not be yours any longer. That is the nature of things. But if you are reading about estate planning, chances are that you care about what happens to your property when you pass away. And if you care about what happens to your property, you care that it benefits the people you want it to go to.
If you give your property away while you are alive, there are a number of risks that could strike. First, there is the issue of taxes. If you have held a piece of property for a number of years, it is likely that the property has appreciated in value. If you die, your heirs won’t be taxed on how much your home has increased in value. But, if you transfer your house to someone else other than your spouse during your life, when they sell the house they will be taxed on the difference between how much you paid and the fair market value at the time of the sale.
For example, imagine that you purchased a home 30 years ago for $30,000. The house is now worth $330,000. If you transferred title to your children during life and then your children sold the house, they would pay taxes on $300,000 worth of gain – or $60,000 when the capital gains rates are 20%. If you transfer the house at death, the basis would “step up” to $330,000, so the gain and the tax would be zero.
Another obvious problem is that when you change title to your property, it is no longer yours. If your children have money troubles, divorce or enter bankruptcy, their creditors could take the property. The same problem exists if your children are joint tenants.
Don’t add children to your property deeds or bank accounts
The other common estate planning “solution” is to add children to bank accounts or as joint tenants (where property passes automatically upon death). Although there are circumstances where this could be appropriate, those situations are rare. You should consult with an estate planning attorney before retitling any of your property.
One problem with joint tenancy is that you have effectively given a share of the property away. So bankruptcy, divorce and other creditor issues could arise even if your child is a joint tenant and not 100% owner. If the child doesn’t have money to pay the creditors, it is possible that the creditors could have the house sold off to pay their debts. You would get your half of the proceeds, but lose the house.
Joint bank accounts are another problem area, especially in families with multiple siblings. In some families, a parent chooses one sibling as joint bank account holder. This sibling then has the “expectation” to distribute the bank account evenly to the others when the parent passes away.
I wouldn’t want to be that sibling! Not only is there potential income taxation on the entire bank account, there might be gift taxes on the transfer as well. That is, of course, assuming that the sibling doesn’t just decide to keep the bank account for him or herself. It happens.
The moral today is that you should not transfer title or add children to joint bank accounts for the purposes of estate planning without the advice from an experienced estate planning attorney. While these transfers and changes might seem like a good idea at first glance, there are simply too many risks behind the scenes.