Ron Bush has been involved in real estate for over 40 years–as an attorney (California, not Oregon) and as a real estate broker. While in law school, he took many real estate-related courses beyond the standard Property Law course. As a practicing attorney, he engaged in Estate Planning (trusts and wills) in addition to handling real estate matters for his clients. His background in Law has proven to be very useful in helping his clients during his real estate career.
The Problem: When people get to a certain age (ask me how I know this), we start thinking about handing down our assets to our children. We want to do this with a minimum of complications and expense; for example: to avoid probate, to avoid attorneys’ fees, to save time, to avoid complications, etc. We may have heard that just “deeding” (gifting) the property does all this, it sounds like a good idea. So, we do it without consulting with a professional (lawyer, CPA, financial advisor). Later, we, or our heirs, get “Surprises”. Here are some, but not all of them.
#1: The Debts Surprise:
If our child, or any of them, has debts (medical bills, child support, taxes, business debts, judgments, etc.) which can attach to real property, those debts will be liens on our home as soon as the deed is recorded. If they incur any such debts after the deed is recorded, then the title may have a lien put against it. If we deed the house to several children, the debts of one child could affect all of the other children’s interests.
#2: The Divorce Surprise:
In Oregon, if our child is married and divorces, our family home could be considered a “marital asset” and subject to being part of the assets divided among the divorcing spouses.
#3: The Surviving son or daughter-in-law surprise:
If we deed our home to a child who is married and our child dies, it is possible that the widow or widower could become the owner of our home. Then what? We might think that everything will be just fine, but there are many court cases that indicate that it often is not.
#4: The Underage child surprise:
Suppose that we want to give property to a child or grandchild who is a minor, deeding the property directly would result in a guardianship having to be set up through the courts. This requires court approval for any action, even if it is to benefit the minor.
If the minor holds title with other persons, those persons’ property interest is also affected because the property cannot be sold or used as collateral for a loan without court approval. Even if it appears to us that this would benefit everyone, if the judge disagrees, it won’t happen.
If there were a trust, with the property held in trust, the trustee could utilize the property, according to the trust terms, without going to court.
Incapacity of our child–illness, trauma, “special needs”–this brings us back to the conservatorship issue above when a minor child is involved.
Drugs, alcohol, gambling, etc. can affect what happens with the property once the afflicted child has title.
#7: The Income Tax Surprise:
Suppose that we bought our home 40 years ago, when real estate values were much lower. For example, we bought our home for $30,000 and now it is worth $300,000, there is a gain of $270,000. If we have directly deeded the home to the kids, after we are gone, when they sell it, they may have to pay thou$ands in income taxes.
Why? If someone receives appreciated property as a gift, they take over the donor’s tax “basis”–what we paid for it originally (plus improvements). If they sell it for $300,000, the difference of $270,000 can be taxable to them. Often, we don’t think about this.
No Income Tax Exemption:
Q. I thought we had an income tax exemption of $250,000 each ($500,000 for a couple) on real estate gain from the sale of our home?
Yes, we did (Section 121 of the Internal Revenue Code), but now the kids own it, and they do not live in it. To qualify for this exemption, they must live in it for 2 of the past 5 years before sale.
Did not “inherit”:
Q. We have heard that heirs take over inherited property at the market value as of the time of death of the decedent. Then, if the house is sold before that value changes, no income taxes are payable?
You are correct–if they had inherited it.
In our case, the tax basis is $30,000. If kids inherited it, they would be qualified to take the home at what is called a ‘step-up in basis’ to the value of the house when we pass on. In this case, if we give it to them while we are still alive, they are not heirs, but “donees”.
Did not ask for expert advice:
Q. “How could we arrange this so as to avoid the income tax bill? We did not see this issue.”
Please consult a professional advisor (attorney, CPA, financial planner), they will be familiar with this issue. The advisor might advise you to set up a “Living Trust”, transfer the property into the trust, and name the kids as the beneficiaries. That allows them to inherit the property, receive the step-up in basis and not have to pay these taxes. Or the financial advisor may have other solutions–See your financial advisor on these points.