Many clients ask me if it would be easier--administratively-- to add their son or daughter on title to the home during their lifetime. After all, adding someone on title could be as easy as executing a new deed with a title company. However, whether or not that child SHOULD be added is really the question that needs to be addressed. Many people do not understand the significant legal and tax consequences of adding someone on title during their lifetime. I'd like to address some of those consequences here.
With the passage of CA Proposition 19, a transfer to a child (even a partial interest) will not avoid property tax reassessment unless the child makes it their primary residence. The child would need to live in the home as his or her primary residence within one year of the transfer and file for the homeowner's exemption within one year of transfer to qualify for the exclusion from reassessment.
There are also unintended tax consequences of adding a child on title prior to your death:
- Gift Tax Consequences: Adding a child on title constitutes a taxable gift. The parent would be required to file a gift tax return to report the gift (one half of the value of the property) and the balance over $17,000 (the annual gift tax exclusion amount in 2023) would be taxable to the parent, not the child. In some cases, a gift tax may have to be paid.
- Reduction of Lifetime Exemption Amount: Even if a gift tax is not paid at the time of filing the gift tax return, reporting the gift will reduce the parent's lifetime exemption amount (or, the amount of money your estate can shelter from federal estate taxes). So, depending on the tax laws the year the parent dies, their estate may be faced with paying estate taxes because they used up too much of their lifetime exemption amount with lifetime gifting.
- Capital Gains Tax Issue: Generally, when a parent dies leaving a house to his or her children, the home will get a step up in tax basis minimizing any capital gains tax they would have to pay if they decided to sell the property after the parent's death. The “step-up” moves the home's value up to the fair market value at the time of the parent's death, not the price the parent paid when they purchased it. However, a home will not receive a step up in tax basis after the parent's death if they add his or her child to the title while the parent is still living. The reason is the child retains the parent's old cost basis (i.e., the price the parent paid when they purchased it), and if the child decides to sell the property later on, assuming the home appreciated in value, the child will have a capital gain on the sale which is subject to capital gains tax.
- Additional Property Tax Consequences: Sometimes parents think that adding a child on title now will make it easier for that child to share the assets with the other beneficiary(ies) later on, but this creates additional property tax consequences. The reason is, even if the child decides to honor his or her parent's wishes and agrees to gift one-half of the property to the other sibling, this would trigger a gift tax consequence similar to the hypothetical above. If the value of one half of the property is more than the annual exclusion amount, then the one child will be required to report the gift to the IRS and potentially pay gift tax or reduce their own federal exemption amount. Additionally, a transfer between siblings will trigger a property tax reassessment for one-half of the property, which could be a problem if the children intended to keep the property.
- Other Unintended Consequences: Adding a child on title can have other unintended consequences, such as exposing the parent's property to the child's creditors (e.g., ex-spouse in a divorce proceeding, judgment holder in a lawsuit, etc.). Further, if the child is added on title, and the parent-child relationship sours (which happens all the time), the parent cannot force the child to deed the property back to them.
In summary, adding a child on title now will not avoid the property tax reassessment imposed by CA Proposition 19, and it exposes the parent's estate to other tax and non-tax consequences.