Potential Consequences of Adding Someone to a Deed
Clients often come to Commons & Commons asking if they should add their loved ones (most often, their children) to their deeds. In Pennsylvania, where there are no “beneficiary deeds,” clients generally make this request so that their property can pass to those surviving owners at the client’s death without the need for probate. In most cases, other than adding a spouse as a joint owner, this is not a solution that we recommend. To explain why that is, outlined below are some of the potential benefits and drawbacks to creating a joint tenancy with right of survivorship (i.e. adding children to your deed).
Benefits:
Probate avoidance. By adding someone to a deed as a “joint tenant with right of survivorship” you can ensure that property passes automatically to that person upon your death (assuming they survive you), without the need for probate (the formal process of raising an estate) for that particular asset.
Reduction (not avoidance) of PA Inheritance tax. Jointly owned property (even with right of survivorship), as long as it was made joint more than one year before death, is taxable for PA Inheritance tax purposes to the extent of the decedent’s fractional interest in the joint property. This means that if two people own a property as Joint Tenants with Rights of Survivorship, the survivor will owe Inheritance tax on the ½ interest they inherited when the other person died, calculated at the applicable tax rate (0% between spouses, 4.5% on inheritances passing to lineal descendants, 12% to siblings, 15% to others). If the Inheritance tax is not paid at the time of death, the Commonwealth can still assert its right to payment later and a title company will not insure a sale if there is outstanding Inheritance tax due.
Drawbacks:
Opening up the property to claims of the new owner’s creditors. Property owned by joint tenants is subject to the claims of creditors of any of the owners. This means that if a co-owner is sued, and a judgment is entered against them, the person or entity who sued them can put a lien on the property. Additionally, if one of the joint tenants goes through a divorce, that person’s interest in the joint property would be part of what is divided up as part of the divorce proceeding.
Potential disputes with new owner. When you add someone to your deed, they become co-owners of the property. That means they will have the same rights and responsibilities as any other owner. For example: they will have claim to live in the home and cannot be easily evicted; they will have the right to go to Court to get an order that the house be sold, and the proceeds of the sale distributed to all co-owners; and if you want to borrow money in the future to make repairs on your home, they will be required to consent to any mortgages.
Loss of (some) step-up in basis. The sale of a home can trigger the imposition of capital gains tax on the seller. The amount of tax owed is based on the difference (the gain) between how much the house was purchased for (with the addition of money spent on capital improvements) versus how much the house is sold for. However, in the US, the value of a property is “stepped up” in basis when the property owner dies, thereby giving the beneficiaries the benefit of the new, usually much-increased basis. Then, when the beneficiary sells these assets, capital gains taxes are calculated only on the sale price that is above this (usually much higher) “stepped-up” basis. This “step up” in basis for federal purposes occurs for the full portion of the property that the decedent contributed to (e.g. the portion originally owned, even if some was gifted away), but for Pennsylvania purposes there is no “step up” for assets that are acquired through joint ownership. Therefore, by adding an intended beneficiary to a deed before death (reducing the portion owned by the original owner), the beneficiaries are deprived of the benefit of a “step up” for PA tax purposes.
Potential capital gains consequences if property is sold prior to death. Again in conjunction with the taxation of capital gains, if the property is sold with a gain (which is often the case), and the seller lived in the property as their primary residence for two out of the last five years, then the seller gets to exclude the first $250,000 of gain before any capital gain is taxed (this is doubled to $500,000 for a couple). For many sellers of real estate, this means that no capital gains taxes are paid when houses are sold. However, if the property were sold prior to death, the joint owner would still realize gain upon the sale of property and, unless they individually met the principal residence requirement, not be able to take the exclusion - thus leading to the imposition of tax on the joint owner that could otherwise be avoided.
Potential Inheritance tax owed if joint owner(s) die “out of order.” If the newly added owner were to pass away prior to you, Inheritance tax would be owed (most likely by you) on their share that passed back to you, even if it originated with you in the first place (this is the flip side of the coin that results in your estate potentially owing less in Inheritance tax if you add joint owners).
Requirement of the Federal Gift Tax return. A gift tax is a federal tax imposed by the IRS on individual taxpayers who transfer property above a certain value to someone else (other than a spouse) without receiving anything of substantial value in return. Adding someone to a deed without asking for any payment is a type of gift. Although for the vast majority of people gift tax is never owed – the amount you are allowed to give away before tax is imposed is many millions – a gift tax return is still required to be filed for any “major” gifts.
Impact on future Medical Assistance. If you do not currently receive Medical Assistance but believe that you will need to rely on in-home nursing assistance or nursing home care in the next five years, you should think carefully about adding someone's name to your deed. When you apply for assistance, DHS will ask whether you have given away any property within the last five years. If you have added a child to your deed without asking for payment, you may be subject to an ineligibility period based on the value of interest in your home that you gave away.
Conclusion: Many times, when someone seeks to add a person to a deed, rather than dispose of property via other methods of estate planning (such as via a Will or Trust), they do so with the assumption that probate and associated Inheritance taxes can be avoided without any downside. It is unfortunately not quite that simple. Probate is difficult to avoid in its entirety, and having an estate go through probate is often less difficult and costly than the work of trying to avoid it. It is our general recommendation that you consider all of the consequences and alternatives before adding someone to your deed.
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