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Besides retirement accounts, real property typically accounts for the largest portion of most estates. The question is what is the best way to transfer your home and other real estate assets to your children. There are three primary ways you can transfer real estate: by deed, by a will, or by a trust.
Transfer by a Deed
When you put your children’s name on title to your assets the IRS considers this to be a gift. To avoid gift taxes, you’ll have to consider using the lifetime gift tax exclusion. For wealthy families who need to consider estate tax planning that is a step that should only be taken with competent legal and tax advice. For the rest of us, just know that you’ll need to fill out an additional form at tax time.
While this strategy has the advantage of being direct and immediate, it has several large disadvantages. Because it is a completed gift (yes, in the legal world there are such things as “incomplete” gifts) you are now more financially vulnerable than you were before, and depending on your children’s needs and financial risks they face, your real property could face more danger than before.
Your child also is at a disadvantage receiving the asset as a gift. Unlike inheriting a piece of property, assets gifted keep their basis for capital gains tax purposes. What this means is that if you’ve had a piece of property that you bought twenty years ago that is worth ten times its value now, and your child sells it, their capital gains tax exposure is much higher than if the basis had been reset to current market value when the child inherited the property at your death.
See also Understanding Basis & Capital Gains Taxes
Transfer Under a Will
By waiting to transfer your property until after your death, your children have the advantage of the step up in basis to current fair market value. A will lets you specify who your beneficiaries will be. The disadvantage of a will is that your beneficiaries will have to go to court to probate the will, a process that can easily take more than six months to complete, and cost your beneficiaries thousands in extra attorney and court fees.
Transfer Under a Trust
Like a will, your children inheriting property under a trust will have the advantage of a step up in basis. And a trust gives you a lot of flexibility in providing extra instructions and protections for your beneficiaries. Not only that, but your children also completely avoid probate court, saving them the time and expense of probate court.
Which method of transfer is best for your particular situation can depend on other circumstances. A conversation with your estate planning attorney can help you evaluate the pros and cons of these and other potential options.