By Lane V. Erickson, Idaho Estate Planning Attorney
The uncertainties of life have never been more apparent than they are now with the Coronavirus outbreak that has affected the entire world we live in. The setting is a great opportunity for me to remind you of the importance of not panicking. I found that whether it is a pandemic, or a more personal emergency, such as a sudden health issue, sometimes people panic and make bad decisions, especially when it comes to estate planning.
My goal as an estate planning attorney who has practiced for more than 20 years is to help people make good decisions. These decisions should be informed, and well-thought-out, and should consider the persons, personalities, and situations that exist for you, your family, and loved ones.
One of the issues that I’ve seen from time to time when an individual does panic about their estate planning is that they transfer their home from themselves to their children. This is usually done through a quit claim deed. I found the people do this for various reasons. Some people want to avoid probate. Some people want to be able to qualify for Medicaid benefits. Some people simply feel like it is simpler and easier if they add their children to the deed to their home. However, the effect of doing this is usually far more detrimental than any benefit.
The purpose of this article is to describe in simple terms why in most instances it’s a bad idea for you to gift your home to your kids while you are alive. Keep in mind that no article can provide all the details or information that you need to understand. However, this article is a good place to start if you are considering gifting your home to your children in any way while you are alive.
Loss of Homestead ExemptionIdaho is a state that provides a specific homestead exemption for a person’s home or residence. The reason this is provided is both for protection from creditors, and also to give the homeowner a break on property taxes.
Homestead exemption is usually declared through a written document that is provided to the tax assessor in the county where your home or residence is located. This could be done at any time. Normally, this is done when a person purchases a home through the closing process. Because of this, most people don’t even know that it has been done. However, when a person receives their tax assessments, they can see the existence of the homestead exemption.
While there are some instances where through a mortgage, or some other kinds of consensual or non-consensual liens, a creditor could foreclose on your home, in most instances, your home is protected from your creditors through your homestead exemption. In other words, even though liens can be obtained, in most instances, it is not worthwhile for a creditor to try to foreclose on your home because of the homestead exemption that exists.
While you have the homestead exemption, you have this additional layer of protection on your home from your creditors. However, if you deed your home to your children, through a quit claim deed or a gift deed, you are no longer entitled to have the homestead exemption, even if you continue to live in the home. Simply stated, you will lose your homestead exemption if you gift your home to your children through a deed.
Capital Gains TaxesIn addition to losing your homestead exemption, if you gift your home to your children while you are alive there could also be substantial capital gains that your children will be required to pay when they sell your home. This is calculated through what is known as cost basis and sales price.
Without getting too technical, the cost basis of the home is typically the price a person paid when they purchased the home. For most parents, this means the purchase price of the home they paid many decades earlier. It’s more than likely that the value of a parent’s home has gone up over those decades and it is now worth far more than it was when they first purchased it.
If a parent gifts their home to their children while the parent is alive, the child receives the same cost basis that the parent themselves had. The capital gain is the increase in value in the home above the original purchase price. The capital gain is taxed requiring the child to pay money to the government simply because the parent gifted it to them while they were alive.
However, if a child receives a parent’s home through the parents estate after the parent passes away, then the child gets to enjoy what is known as a step-up in basis. This simply means that the child’s cost basis will be the actual value of the home when it is transferred, rather than the value of the home when the parent purchased it many decades earlier.
Again, to keep it simple think about it in this way. If you gift your home to your children while you are alive, and your children immediately sell it, there will likely be a substantial capital gains tax that will have to be paid. However, if your children receive your home as part of your estate after you pass away, and your children sell the home immediately, there will be little to no capital gains tax because of the step-up in basis your child receives.
When it comes to capital gains taxes, the bottom line is that it is usually far better for a child to receive the home as an inheritance after your death, rather than a gift while you are alive.
Your Kids’ CreditorsIn addition to the loss of the homestead exemption and potential capital gains taxes, your home could also be at risk to your children’s creditors if you transfer your home to your children while you are alive.
Most people have creditors. Additionally, any liability that could be created through a car accident, or some other type of personal injury that occurs, or some type of business liability, will result in a creditor. Creditors have a right to be paid. The law creates certain systems and processes that allow creditors to force payments to be made to them.
Any property that your children own, that are not exempt under the law, can be taken away by creditors to pay any debts your children have. This is regardless of how that debt was created. As a result, if you gift your home to your children, and the home is not your children’s primary residence, they are not entitled to a homestead exemption in the home. If your children have a creditor, they will have a right to foreclose on the home to pay for the debt that exists.
In other words, regardless of what your original plan may have been, if you gift your home to your children, the home could be lost to your children’s creditors. However, if you only gift your home to your children through your estate planning, which means your children only receive it after you have passed away, your home cannot be taken away from you by your children’s creditors.
ENLIST AN IDAHO ESTATE PLANNING ATTORNEY TO HELP YOUOur team of Idaho lawyers can help you with any of your estate planning or probate needs. Whether you are seeking to create or review an estate plan for yourself or would like to help a loved one, we are available to discuss your options and answer your questions at an initial free 30-minute consultation. Call us toll free at 877.232.6101 or 208.232.6101 for a free consultation. You can also email us directly at lane@racineolson.com or stop by our office at 201 East Center Street, Pocatello, Idaho 83201. We can set up an appointment to answer your questions and help you solve your Idaho estate planning problems.