Many people are familiar with probate and all of the headaches which it entails. Whether they’ve lost a loved one or a friend, no one who goes through the probate process looks at it with a friendly gaze.
I often have clients come into my office having made an attempt to avoid probate on their own. Commonly, they have tried to avoid it by adding children’s names to real property, investment accounts, or bank accounts. While they may have succeeded in ensuring their children will avoid probate, they have usually created a much bigger problem.
When you purchase an asset (such as stock in a corporation or piece of real estate) you are assigned a “basis” in the property. Your basis is the value you paid for the property. For example, if you bought an investment property for $100,000, your basis in the property is exactly that: $100,000. If you sell the property for more than you paid for it, you have to pay capital gains tax on the difference.
If you give away your property (or add someone’s name to the deed), their basis in the property becomes the same as yours. In the scenario above for example, if a child’s name was added to a real property deed, the child’s basis in the property would be $100,000. When the parent dies and the child goes to sell the house, the child has to pay capital gains tax on the difference between their basis and what sales price of the property.
So how do you avoid forcing your children to pay capital gains taxes? By NOT adding them to the deed or account!
If your child inherits the property through a revocable living trust, your child will get a “step up” in their basis to fair market value at the date of your death. Thus, if the property above was worth $300,000 at the date of death, the child’s basis becomes $300,000 when they inherit it. This means that if your child goes to sell the property, they will pay no capital gains taxes.
Finally, gifting to your children has other dangerous pitfalls. If you add children’s names to property or accounts, you are subjecting those assets to potential risk if your child were to accidentally injure someone or run up a credit card.
By far, the safest way to pass your family’s wealth on to your children is through a fully funded revocable living trust. Setting up and funding a revocable living trust avoids probate, protects your children from unnecessary taxes, and gives you the ability to protect their inheritance from divorce, lawsuits, and creditors.
Perhaps you already know all of this. Perhaps you don’t. But if you’d like more information on protecting and passing wealth to your children, call our office to schedule an appointment or to RSVP for our next free public seminars (at The Lodge in Sierra Madre: Wednesday, Oct. 21, 2015, 6:00 – 8:00 pm & Thursday, Oct. 22, 2015, 10:00 am – noon).
To your family’s health, wealth, and happiness,