Avoid the Estate Planning Banana Peel – Don’t Add Your Kids on Title to your Home

Many aspects of estate planning in California center around avoiding the need for probate court. Adding a death beneficiary to an asset or adding a co-owner on title to an asset are two ways to avoid the need for probate court when you die. Well, that sounds pretty easy. Why don’t we all just do that and call it a day?

Put simply, adding co-owners and death beneficiaries to assets only addresses one situation: that 1) you have died; 2) that the beneficiary/co-owner is alive upon your death; 3) the beneficiary/co-owner has capacity and is over 18 years old upon your death; and 4) the beneficiary/co-owner does not have creditors nipping at their heels.

There are so many other scenarios that can occur. All it takes is for any one of the four factors above to be false for your simple plan to become complicated and problematic. Besides that, there are tax implications for adding people onto title of your assets.

Let’s illustrate with a common example. A widowed parent owns their own home, and has two children. The parent figures that it would simplify everything if they add their two children onto the title of the home. That way, upon the parent’s death, the children receive the home, in equal shares, without having to go through the probate process.

What gets overlooked in the above hypothetical are the following considerations.

Death v. Incapacity

The only way to avoid probate in the above example is if the parent dies. If the parent is alive but incapacitated (think: dimentia), the children have no authority to act on the parent’s behalf by simply being co-owner of the home. They now co-own a property with someone who cannot handle their own affairs. They would have needed the parent to sign other legal documents, such as a durable power of attorney.

Similarly, if either or both children are incapacitated upon the parent’s death, probate may be necessary to receive ownership of the home unless the incapacitated child signed a durable power of attorney themself. Or, if the children are not yet adults, they cannot own the property outright without legal guardians involved.

Creditors

When the parent adds the children as co-owners to any asset, including their home, the parent is entangled with that child’s financial life, including that child’s creditors. If the child is going through a divorce, or someone is suing them for money, or the child owes taxes or other debts, or if the child files for bankruptcy, then the parent’s home is now subject to the claims of the child’s creditors. The parent may have to figure out how to get their own house back!

Additionally, if the child faces those same creditors after the parent’s death, there is no barrier between receiving full ownership of the house and satisfying those creditors’ claims. Ultimately, the child may end up losing the home to their creditors, which is certainly not what the parent intended.

Creating Capital Gains and Property Tax Problems (Click here for a brief discussion of taxes)

When the parent adds their children to title, the parent is making a lifetime gift of that portion of the home. This in itself could trigger a gift tax issue. Gift tax issues aside, typically when the parent dies, all of the capital gains built into the home are eliminated upon the parent’s death. But only the capital gains associated with the portion of the home that the parent owned at death. The portion of the home that the children now own do not receive what is called a “step up in basis”, and the capital gains for the children’s portion are not eliminated. If the parent kept all 100% interest in the home, then all of the capital gains would have been eliminated. After putting their children on title during their life, the parent is now creating a capital gains problem for the children when they sell the home.

Adding multiple children to title can also create adverse property tax implications. Even though Prop 19 has severely limited the application of the parent-child exclusion, there is still an opportunity for the parent to transfer the home to one or more children with some relief from increased property taxes. However, when more than one child is added as co-owner, the home could get reassessed when one child decides to buy another out in the future since that is not a parent-child transaction.

Co-ownership and death beneficiary designations lack any nuance. It only asks whether an owner is dead, and if the answer is yes, ownership of the asset automatically transfers to the other co-owners or to the beneficiaries in whatever condition or circumstance they find themselves. No discretion is involved to determine whether it’s a “good” situation to transfer ownership of the home to the co-owner or beneficiary. Additionally, It makes you vulnerable to your co-owners’ creditors, and could create unforeseen tax issues for your loved ones. The only surefire way to transfer ownership of your assets, with nuance and full discretion, is to create a comprehensive estate plan.