Protect Your Family: Pass Your Property Down the Right Way
Real estate isn’t just a financial asset; it can be a home filled with memories and sentimental possessions. While leaving real estate behind for your children can be a meaningful gift, there can unfortunately be many potential consequences as well. As a result, passing down your property to your children requires effective estate planning strategies to help you avoid large taxes, probate delays, and family conflict.
Whether you are leaving behind your permanent residence or your vacation home, you must be sure to tailor your plan to be the best fit for your family. You need to understand different tools, such as step-up in basis rules, life estate deeds, and revocable living trusts, and be able to evaluate which is most effective for your situation. Each strategy has its advantages and disadvantages, but it is important to identify which will transfer your real estate in a way that not only avoids complications but also truly protects your family.
Unlock Big Tax Savings: The Power of Step-Up in Basis Explained
If you leave real estate to your children and they decide to sell the property, they may have to pay capital gains tax. Fortunately, there is a way to reduce the amount they pay: here, timing is key. This is where the step-up in basic tax provision comes into play.
If you gift real estate to your children during your lifetime, capital gains tax is calculated based on the difference between your original purchase price (the basis) and the sale price when your children sell the property. As real estate prices continue to rise, this difference can be astronomical. However, if your children inherit the real estate after you have passed away, the IRS allows the basis to be “stepped up” to the value of the property at the time of death of the owner. This can completely eliminate capital gains tax if your children choose to sell the property for that amount. Even if they sell it later at a higher price, the exposure to a capital gains tax is significantly reduced. Understanding this concept can save a lot of money in taxes.
For example, let’s say you bought a house about 40 years ago for $100,000, and the value of the home has appreciated to $1 million. If you gift the home to your children during your lifetime and they sell it, they will owe about $900,000 in capital gains tax. In this case, leaving the house to your children following your death would save them almost $1 million if they sell the property for that amount.
The bottom line is that the timing of a generous gift like your real estate is crucial. We recommend that you wait to transfer your property until after your death in order to offer tax savings through a step-up basis.
When Gifting Property Now Beats Waiting: Strategic Reasons to Transfer Real Estate During Your Lifetime
Although we just discussed why a step-up in basis is extremely helpful and effective in saving your children from taxes, there are some situations where it still is strategic to transfer ownership during your lifetime. If you are planning to apply for Medicaid, owning a high-value home may prevent you from being eligible for certain benefits. That is why, in this case, it may make sense to place your home into a trust or life estate deed to ensure that your house isn’t counted as an asset and therefore doesn’t interfere with your ability to get Medicaid coverage. One key detail to note is that Medicaid has a five-year lookback period, meaning, if you transfer your home within five years of applying, the state will believe that you made this transfer to qualify for Medicaid unfairly, resulting in them delaying your eligibility.
Another reason why people may choose to gift real estate during their lifetime is to avoid probate. This is the process that occurs after you pass the court, validating your will and distributing your assets. Probate can be extremely stressful, time-consuming, and costly. When you give property to your children while you’re still alive, that property is no longer part of your estate when you pass away, which means it doesn't have to go through that process. These are cases where it strategically makes sense to gift real estate during your lifetime; however, it is important to ensure that this is worth it for you when comparing it to the potential capital gains tax your children might have to pay.
Trusts 101: The Smartest Way to Keep Your Property Safe and Skip Probate
We recommend revocable living trusts as the most flexible tool for estate planning. When you put your home into a trust, you still maintain complete control of your property, but name your kids as beneficiaries, meaning that when you pass, the property goes directly to your kids while bypassing probate. This strategy keeps the process private, unlike probate, which is public record; furthermore, it can speed up the transfer and often reduces legal costs. This is a great tool to ensure that everything that happens after you pass aligns with your interests. With a trust, you are able to leave thorough instructions and outline your wishes for your heirs.
Life Estate Deeds: A Simple Solution for Seamless Property Transfer
Another option is to use a life estate deed where you grant yourself a “life estate,” meaning you can use your property for the rest of your life, and your kids a “remainder interest,” giving them ownership following your death. After you pass, your property automatically goes to your kids and avoids probate. We recommend this as a less costly and complex option. Your children may also qualify for a step-up in basis, meaning if they sell the home after your death, they could owe little to no capital gains tax.
One disadvantage of a life estate deed is less control: you cannot sell or refinance the property without the child’s permission. This isn’t a problem as long as you have a close relationship with your child. You want to ensure that you won’t have to navigate challenging family dynamics when you are giving control to one of your family members.
Your Next Steps: How to Create a Solid Plan for Passing Down Your Home
To begin, it is important that you create an inventory of the properties you own. Make a plan for who you believe should inherit each one. Make sure you consider your children’s financial stability and ability to maintain the home when making these decisions.
We recommend that you discuss your plans with an experienced elder law attorney. A professional will help you create the right approach that is best suited for your family dynamics and situation. Call (718) 333–2394 today to speak with the Law Office of Inna Fershteyn to ensure that this valuable gift you pass on is a blessing and not a burden for your loved ones.