A scenario I frequently encounter is a parent wanting to avoid probate and keep things simple for their children by adding one of their children to the title of their property. Is it effective? Yes. Jointly titled property (JTROS) passes to the surviving owner automatically upon the death of the joint owner. The goal of avoiding probate has been accomplished but at what cost?
By passing title solely to a joint owner, that surviving owner now has unrestricted title to the property in question. If your intention was for the joint owner to divide the property with other children or to include the property in the overall estate, there are no guarantees that will happen. The surviving owner has no legal obligation to now divide the property. You can certainly hope that they do the right thing but there is no requirement they do so.
Also, as the sole owner of the property they are now personally on the hook for all the liabilities associated with property ownership. They must now insure the property in their name; they are now individually responsible for property taxes.
Unintended Tax Liability
Most importantly, they have may have a significant capital gains tax liability at the time the property is sold. This is probably the most important consideration when contemplating this probate avoidance scenario.
Ordinarily when you sell a property, capital gains is calculated based on the original purchase price and the sale price. If you are selling your residence, you may qualify for a Primary Residence Exemption. However, your heirs likely will not qualify for that exemption and will therefore have to pay capital gains tax (usually greater than 20%) on the difference between your original purchase price and the sale price. If you have lived in the same home for decades, this difference is likely quite significant.
If the property was passed as an asset of your estate, your heirs receive a “step up” in the basis value of your property to the value at the time of your death. Thus, rather than paying taxes on the difference between your original purchase price and the sale price, they only pay taxes on the difference between the value at the date of your death and the sale price – likely a very reduced tax liability, if any.
If only there was a way to avoid probate AND avoid this capital gains tax liability…
There is. Passing property through a Living Trust allows your heirs to avoid probate and still receive the “step up” in basis to avoid the significant capital gains tax liability.