A home is one of the most valuable and complex assets to hand down. It can be an incredibly emotional experience and may be difficult to find common ground. Thoughtful planning can ensure your home is passed along according to your wishes. A well-constructed plan can minimize the risk of legal, financial, and tax complexities. If you’re proactive, your heirs can have clarity and a clear course of action for when the time comes.
1. Start planning early.
Start early and discuss your intentions with family members and heirs. Understand their wishes and ensure your decisions align with their hopes for the future.
2. Understand the potential tax consequences.
Transferring property to an heir can trigger various tax consequences, including estate taxes, gift taxes, and/or capital gains taxes. Work with an estate planning attorney or tax professional to implement a tax-efficient transfer strategy.
3. Explore different transfer options:
Joint ownership — If you plan on living in the home until you pass away, you may wish to add your heir’s name to the property’s title as a joint owner. This ensures that the joint owner receives full ownership rights to the home without restrictions after one’s passing.
If a spouse is listed as the co-owner of the home, the value transferred to the spouse is exempt from estate and gift taxes as they benefit from the unlimited marital deduction. The surviving spouse would inherit your ownership interest of the home and become the sole owner.
When a non-spouse co-owner is listed:
• The value transferred is considered a gift and must be reported for gift tax purposes, meaning it counts toward your lifetime exemption amount.
• Lifetime gifts to non-spouse heirs are subject to the carryover of cost basis, which may be equal to the original cost of the home (excluding improvements). This means they may be subject to higher taxes due on the future sale of the property because they’ll likely not be eligible for a step-up in cost basis at the time of your death.
• As a co-owner, your heir assumes ownership of a portion of the home’s value. Should they experience financial difficulties, initiate divorce proceedings, or incur debt issues, this could put your home at risk of a lien or other legal action. Further, you would need the permission of your co-owner to take out a new mortgage, refinance the existing mortgage or sell the home in the future.
Will — A traditional will allows you to name an heir as the beneficiary of your home. A testamentary trust setup can provide more control over how your home is managed and used. Having a will alone doesn’t prevent your assets from going through probate. And a will is a public document, so anyone can see who inherited assets.
Revocable trust — A revocable trust allows you, as “grantor” or “trustee,” to maintain control over your home while specifying how and when it will pass to your heirs. Following your death, the trust enables your home to be quickly and privately transferred to your heir while bypassing the probate process. This approach allows you to retain full control and use of your home during your lifetime and a seamless transition after you pass away.
Qualified personal residence trust (QPRT) — A QPRT can help you transfer your home’s ownership at a reduced gift tax rate. Here, the home is transferred to a trust, but as the owner, you maintain the right to live there for the QPRT’s duration. At the end of the trust, the house is transferred to the designated beneficiary, and you no longer have an official right to live there (however, it’s common to negotiate a lease with the beneficiary).
For this strategy to be most effective, the original owner must outlive the terms of the trust. If you die before the trust ends, the value of your home will be included in your taxable estate.
4. Evaluate financial readiness.
Make sure your heir is financially prepared for homeownership and the commitments associated with the property. Passing down a home can mean additional financial responsibilities, including property taxes, home insurance, maintenance costs, and mortgage payments.
Gene Gard, CFA, CFP, CFT-I, is a Partner and Private Wealth Manager with Creative Planning. Creative Planning is one of the nation’s largest Registered Investment Advisory firms providing comprehensive wealth management services to ensure all elements of a client’s financial life are working together, including investments, taxes, estate planning, and risk management. For more information or to request a free, no-obligation consultation, visit CreativePlanning.com.
