Parents will often add a child’s name to their bank accounts, home, and other assets, believing it will make it easier for the child to help them manage their finances and their property as they grow older. While this “do-it-yourself” estate planning approach is fairly common among aging parents, the truth is that adding your child’s name as an owner is often not the best choice – for you or your child.
There are two main reasons why you should not include the name of a child (or anyone other than your spouse) on your assets:
- It exposes you to unanticipated liability and risk.
- It will likely deprive your son or daughter of an important tax break after your death.
Let’s take a closer look.
Partial Ownership of Property
When you add a child’s name to your deed, bank accounts, investment accounts, and other assets, you are effectively giving the child partial ownership of your property. In turn, if your son or daughter has financial troubles down the road (for example, owing money to the Internal Revenue Service, filing for bankruptcy, or becomes subject to a judgment), a creditor can place a lien on your property and potentially take it to settle the debt.
The same is true when children marry. If your child’s name is on your property and he or she later divorces, the ex-spouse could be entitled to a share of the property – your property.
Also, keep in mind that if you add your child’s name on your home or other real property, you cannot sell or refinance without your child’s permission, and your child may sell his or her share without you even knowing about it.
Better Estate Planning Choices
Rather than subject yourself to unnecessary risk, there are several estate planning options to achieve your wealth transfer and asset protection goals other than simply adding your child’s name to your assets.
One alternative is to create a power of attorney. A power of attorney is a legal document that gives another person (e.g., your child) the authority to manage your bills, investments, real property transfers, taxes, and so forth. Most importantly, a power of attorney does not give your child any ownership interest in your assets. Therefore, if the child files for bankruptcy or gets divorced, creditors and former spouses cannot touch your property. Also, the document can be drafted using language that limits the scope of your child’s responsibilities and authority over your assets.
A trust is another worthwhile estate planning tool. With a trust, a fiduciary (the trustee, which can be you during your lifetime) holds title to property (the trust estate or trust property) for your benefit during your lifetime and for the benefit of another (for example, your child) after your death.
A trust survives the death of the person who created it (the settlor) and allows the transfer of assets from one generation to the next. If you want additional protection and long-term oversight of your assets, then a trust is highly recommended.
Estate Planning and Tax Implications
If you add your child’s name on your property before you die, you also deprive your child of the “step-up basis” at the time of your death – an important tax advantage for your heirs.
The step-up basis allows your heirs (which can include your children) to only be taxed on capital gains – the difference between the purchase price and the sale price – realized from the time of your death to the time the asset is sold. Here’s how the step-up basis works:
Say a father bought a home for $100,000 in 1995. The home is worth $300,000 in 2005, at which time the father adds his son’s name to the deed. At the time the son is included on the deed, he received one-half of the property’s value ($150,000). The son also received one-half of the cost basis, or $50,000 (one-half of $100,000). Upon the father’s death in 2005, the son sells the house for $300,000. The son then must pay capital gains tax on the $100,000 profit. Depending on the capital gains rate, the son could be faced with a rather hefty tax bill.
But if the father does not add his son’s name to the home in 2005 and, instead, the son acquires the home after the father dies, the son will receive a step-up in tax basis for purposes of selling the home. This means the son will likely pay minimal, if any, capital gains tax on the $100,000 profit.
Bottom Line: Consult an Attorney
Tax laws can change dramatically, as reforms under the Trump administration have shown, providing or foreclosing wealth transfer opportunities for you and your children. Whatever your net worth, asset transfers, asset protection, and wealth preservation must be properly structured (especially in high net-worth families and estates). If you have questions about estate planning, including powers of attorney, trusts, and deeds, as well as tax implications, please contact Kate Gadbois at email@example.com or (269) 324-3000.