Legal Pitfalls of Adding an Adult Child to the Title of Your Home

Adding an adult child to the title of your home might seem like a straightforward way to simplify estate planning, avoid probate, or show generosity. However, this seemingly simple action can have significant legal and financial repercussions that many homeowners overlook. Before making this decision, it's essential to understand the potential pitfalls and consult with an experienced estate planning attorney.

1. Gift Tax Implications

When you add an adult child to the title of your home, you may unintentionally trigger gift tax consequences. The IRS views the addition of another person to your property's title as a gift. If the value of the interest in the property exceeds the annual gift tax exclusion (which is $18,000 as of 2024), you may need to file a gift tax return. While the gift tax itself might not be immediately payable due to the lifetime exclusion, this could reduce your available exemption for future gifts or your estate's exemption after your death.

2. Loss of Control/Exposure to Your Child’s Debts

Once your child is added to the title, you no longer have full control over the property. Decisions regarding the sale, refinancing, or mortgaging of the property will require your child's consent. This loss of control can lead to complications, especially if your relationship with your child changes or if your child encounters personal financial difficulties, such as divorce, bankruptcy, or other creditor issues. If your child encounters financial trouble, creditors may place liens on the property or force a sale to satisfy the debts. This could result in the loss of your home or the need to pay off your child's obligations to avoid foreclosure.

3. Capital Gains Tax Issues

When your child is added to the title of your home, they inherit your cost basis in the property. If your home has appreciated significantly in value, this could result in a substantial capital gains tax when the property is eventually sold. In contrast, if your child were to inherit the property after your death, they would receive a "step-up" in basis, potentially eliminating or greatly reducing any capital gains tax liability.

4. Property Tax Reassessment in California

In California, adding an adult child to the title of your home can trigger a reassessment of the property's value for property tax purposes. Proposition 13 limits annual increases in assessed value, but transferring property ownership can result in a reassessment at the current market value. This could significantly increase your property taxes, potentially making it financially burdensome to retain the home.

5. Complications in Estate Planning

Adding your child to the title of your home can complicate your broader estate plan. This action may unintentionally disinherit other heirs or create tension among family members. If you have multiple children, adding just one to the title could result in an unequal distribution of your assets, leading to potential legal challenges after your death.

While adding an adult child to the title of your home might seem like a convenient way to manage your assets, it’s crucial to consider the potential legal and financial ramifications. The unintended consequences could far outweigh the perceived benefits. Before making any changes to your property title, consult with an experienced estate planning attorney who can help you explore alternatives, such as creating a trust, that can achieve your goals without the associated risks. Proper planning can ensure that your intentions are honored while protecting your financial security and your family's future.

Proposition 19

Californians have passed Proposition 19 with a little over 51% of the vote. It will significantly change the California property tax scheme as it applies to parent-child transactions.

There are two main components to Prop 19:

1. Over-55 Rule. The first component allows homeowners who are either over 55, have severe disabilities, or are victims of natural disasters or hazardous waste contamination to purchase a new residence and retain their property tax assessment from thier current home. In other words, you can “take” your current property tax rate with you to your next home, even if the new home is worth more than your current home. And you can do this up to 3 times in your lifetime. This provision takes effect on April 1, 2021.

1. Limited Parent-Child Exclusion. The second component dramatically limits what is called the “parent-child exclusion” from reassessment. Parents may no longer transfer unlimited amounts of property to children and escape reassessment. This one takes a bit more explanation. This provision takes effect on February 16, 2021.

A Brief Explanation of the Parent-Child Exclusion

In very broad terms, the California property tax scheme--or “Prop 13”--taxes owners of real property (the legal term for “real estate”) based on the property’s “assessed value.” To keep things simple, think of the “assessed value” as the purchase price of the property. Based on that purchase price, the tax collector imposes a ~1% tax. The property tax is not adjusted until or unless there is a “change in ownership.” When there is a change in ownership, the value of the property is reassessed. Reassessment can increase the property taxes dramatically for the new owner. 

In 1986, California voters allowed for an exception to the general “change in ownership” rule that triggers reassessment. The exception is that if parents transferred their property to their children (either by gift, inheritance, or sale), then the assessed value (i.e. property tax rate) would carry to the children. In other words, if you received property from your parents, you would continue to pay the property tax rate your parents were paying. This exception was unlimited when parents transferred their primary residence, and was limited in value when parents transferred property that was not their primary residence (e.g., vacation home, rental property, etc.).

Now let’s fast forward to February 16, 2021. When Prop 19 takes effect, the parent-child exclusion described above will be abolished. In its place will be a far more limited exception. The new exception only allows escaping reassessment if parents transfer property to their children AND the children use the transferred property as their primary residence. In other words, if the children do not live in the house and want to use it as a rental property (or keep it vacant) then the property will be reassessed. 

For example, if a parent bought a house in 1972 for $200,000, then their property tax might be $2,000 a year, regardless of the house’s increasing market value. If the parents transfer the home to a child (either gift, inheritance, or sale) after February 16, 2021, and the child does not live in the house, the property will be reassessed to its current fair market value (say $2,000,000) and the tax will jump to $20,000 a year.

Your Options Going Forward

There is no straight answer here. There are MANY unknowns at play here: the pandemic, a potential recession, other changes in the law in the near future, and particulars about your life and family. All that we know is that Prop 19 will dramatically change parent to child transfers going forward. If you were planning to leave your children property with the presumption that they would enjoy property tax savings, then you may want to consider transferring to them prior to February 2021. However, please understand that a lifetime transfer now may carry capital gains implications forward to your children. It’s a balancing act. We cannot emphasize this enough: there is no one-size-fits-all solution here. Contact us immediately to discuss your situation, things you can consider, and available options.

A side note on timing: The California election is not certified until December 11. After that, there will be regulations that are issued about how Prop 19 will be implemented and how it will work. While we can provide guidance at this point, there are still some questions outstanding that we won’t know the answers to until after that date.