Myth No. 1: You have to specifically list your home in your will.
When you draft your will, you can include your home in the assets you distribute. For example, you can leave it to multiple children and direct them to sell it and split the proceeds. It’s easy for you to include your home among the assets distributed after your death. All you have to do is ask your attorney to include it in your will.
However, even if the home is not specifically identified in your will, it will pass to the named beneficiaries of your estate. On the other hand, if the owner prefers that the home pass to anyone other than, or in addition to, those included in the will, then the lawyer will need to specifically identify the home and to whom it is intended to pass.
Myth No. 2: The heirs are in for a major capital gains bill.
Say the grown children inherit the home they grew up in, which their parents have lived in for 40 years. It’s probably appreciated a lot. But the gain, no matter how much, would be erased as a result of stepped-up-basis-at-death provisions. The date-of-death fair market value of an inherited asset — like a house — becomes the new basis and is subsequently used for calculating capital gains taxes when the inherited asset is sold.
Here’s how it works: Let’s say Mr. Jones (Senior) bought his house for $50,000. When he dies and leaves it to his son, Junior, it’s worth $150,000. If Junior sells it right away for $150,000, he owes no capital gains tax. He does not have to declare a $100,000 “profit” based on the difference between what his father paid for it and what it’s now worth.
If Junior holds on to the property for several years and the house rises in value so he can sell it for $200,000, then he does owe capital gains — but only on the $50,000 difference between the valuation when he inherited it and the price he sold it for. (We’re assuming he has not made any further improvements to the property that would increase the basis.)
Myth No. 3: A revocable living trust can solve all your problems.
Actually, it can solve at least one problem: Your heirs get your home upon your death without having to go through the expense and time of the will probate process. But it doesn’t change the capital gains situation, which probably isn’t a major issue anyway, as noted above. And a trust can cost thousands of dollars to set up.
However, unlike a will, a trust’s provisions are largely private and it may smooth the process, particularly in high-net-worth families with complex estate planning needs. Talk to an attorney before deciding to go this route.
Myth No. 4: You can avoid inheritance problems by adding your children to the title of your home while you’re still alive.
Although this is legal, it can lead to ghastly problems. First, much of the basis step-up noted above is gone — it only applies to the part still owned by the parent, so if one or more children sell it upon the parent’s death, the capital gains tax bill could be significant.
Insurance needs change as well — the children are exposed to liability issues as owners. And the parent is at risk if a child gets into trouble and as a co-owner needs the equity in the house due to debts. Although this technique, like a trust, allows heirs to avoid probate, most financial planners recommend against title sharing because of the possible problems.
Tax laws and tax rules are constantly being updated and interpreted. This article contains general information, so please discuss your individual situation with a trusted tax adviser before making tax decisions.