Nearly once a month a parent or single family member will contact our office and want to discuss adding the name of a child or family member to their bank account, home or other assets believing this will make it easier to manage their finances as they grow older and after they pass away. Adding the name of a child or family member to the legal title to an asset is often not the best choice for the following reasons:
Tax Basis and the Loss of Using The Step Up in Basis Rules
The tax basis of an asset determines whether there will be a taxable gain or loss upon the sale or disposal of the asset. The tax basis of an asset can be determined in a variety of ways the most simplistic being the cost of the asset plus the value of any improvements made to the asset over time. If the recipient of a gift did not purchase the asset but instead received the asset as a gift, then the recipient of the gift takes the the value of the percentage interest of the tax basis of the donor as the recipient’s tax basis.
As an example assume a mother bought a lakefront property 40 years ago for $100,000 and made very little to no improvements to the lakefront property over time. Now that lakefront property is worth $ 3.0 million. The mother is evaluating whether to add her daughter to the deed to the lakefront property as the sole co-owner of a fifty percent interest with the mother as a tenant in common. If the mother added her daughter to the title of the lakefront property as a 50% co-owner the tax basis of the daughter in the lake front property is $ 50,000 plus any gift tax paid by the mother. Assuming the mother paid no gift tax, the daughter’s tax basis is $50,000. Following the death of the mother and assuming the mother’s 50% share in the lakefront property passes to her daughter who is the only other existing co-owner, if the daughter sells the lakefront property for a net sales price of $ 3.0 million after all expenses associated with the sale (realtors commissions, title insurance, surveys, attorney fees etc.) then the daughter will have a taxable gain of $ 1,450,000 upon which the daughter must pay federal capital gains taxes and state income taxes. The state and federal taxes on the gain on this sale of the lakefront property could exceed $300,000.
If the mother had not added her daughter’s name to the title of the lakefront property but instead provided the daughter would receive the lakefront property pursuant to the terms of her mother’s revocable living trust or last will and testament, then under current tax laws the daughter would receive a step up in basis for the lakefront property to the fair market value of the lakefront property at the time of death of her mother. By taking this approach the daughter would pay minimal capital gains taxes upon the sale of the lakefront property instead of the $300,000 + in taxes as outlined in the prior paragraph.
Ability of Creditors to Attach Gifted Property.
When an individual gifts property and adds the name of another person to the title to an asset the recipient of the gift becomes a co-owner of the asset and is presumed to own a fifty percent interest in that asset unless otherwise designated. As a co-owner of an asset in the form of a tenancy in common the creditors of the gift recipient can possibly attach and liquidate the gift recipient’s interest in the gifted asset to satisfy debts owed to the creditor of the gift recipient. If the marriage of the gift recipient ends in marital dissolution proceedings a former marital partner may claim the value of the gifted asset as a marital asset for which the former marital partner may wants to claim fifty percent of the value of the equity in the the gifted asset as part of a property settlement agreement. If the gift recipient whose name the donor added to the title to an account or asset filed a bankruptcy petition, the interest of the gift recipient in that gifted asset would be an asset of the bankruptcy estate and subject to assignment to the bankruptcy trustee for the payment of claims of creditors of the gift recipient.
Loss of Flexibility
As the sole owner of an asset an individual retains the most flexibility to control the use and disposition of that asset. Over time circumstances often change within most families. Some of these changes in family dynamics may be good and some may be not so good. Often times the child who is most involved in assisting for the long term care of a parent or loved one is also the child who is most financially successful compared to their siblings. The other siblings may need the monies more than the sibling who helps the parent out the most with long term care and the child who is also the most financially secure. It is not unrealistic desire for a parent to want to give more monies or assets to one or more children who have greater financial needs than another child. As an estate planning client recently commented to me, ” $250,000 is a lot of money to my daughters # 1 and # 2, while to daughter # 3 who has her own professional career and is married to a very successful business executive, the sum of $ 250,000 is not as significant of a sum of money that is going to change the lifestyle of daughter #3 whether she inherits the $ 250,000 or not .”
Rather than limit your flexibility and expose your family to the payment of unnecessary taxes there are options to achieve wealth transfer and asset protection other than simply adding the name of a child to a property or account.
A durable power of attorney is a legal document that gives another person (i.e. your daughter) the authority to manage your bills, investments, transfers of real estate and other assets upon your inability to perform these tasks. The individual who holds your durable power of attorney does not obtain an ownership interest in your assets but instead this person is conferred with the legal authority to manage your assets upon the occurrence of a certain event (i.e. your disability as determined by a doctor). A durable power of attorney can be drafted so as to limit the scope of authority and the acts which the holder of the power of attorney can or cannot engage in on your behalf.
A revocable living trust is another option to consider as far as the future administration of your assets. The terms of a trust enable a fiduciary (i.e. the trustee who initially can be you as the creator of the trust) to hold title to property for you during your lifetime and after the death of the creator of the trust for the benefit of others (i.e. your children or trust beneficiaries). A trust survives the death of the person who creates the trust and allows for the transfer of assets from one generation to the next.
Changing Tax Laws
Tax laws can change dramatically as reforms under the Trump Administration have shown. In the coming year it is anticipated the new political administration will push forward to change some of the existing tax laws. The step up in basis tax laws that have existed for several decades could be changed or limited in scope and size going forward as well as the amount of the federal estate tax exemption.
If you have questions about estate planning including trusts, power of attorneys or deeds as well as the tax implications please feel free to contact our firm.