Table of Contents

A common scenario encountered quite frequently is individuals adding their children to their home’s title prior to death as a joint tenant with rights of survivorship (JTWROS) as a means to avoid probate. While there are logical reasons why doing so may be a good idea, in general, without proper tax and legal guidance, it can backfire for several reasons.

 

State property laws establish the value transferred.

Primary responsibility for property law rests with the states and not the federal government; therefore, in order to determine ownership and value the transfer of ownership, one must look to the state’s property laws and something called severability.

Severability is the ability of a joint tenant to unilaterally sever their interest in a jointly held property, and terminate the joint tenancy, which converts the interest to a tenancy in common (TIC) without the need to consult their other owners. Tenancy in common is a form of co-ownership where each tenant holds an individual, undivided interest in the property with no right of survivorship. Each tenant’s interest can be bequeathed or transferred independently.

 

If one lives in a state where severability exists, then the value at the time of title transfer is an equal split. For example, if you add your son and daughters to title, and your home is valued at $600,000, each of you have a $200,000 interest. If you live in a state where severability does not exist, the arrangement is typically treated as though there is a retention of the right to use and benefit from the property for the individual adding their children to the title, because you cannot be unilaterally ousted by the other joint tenants. This is similar to a life interest, and because of that, a more complex calculation needs to take place in determining the valuation of the interest transferred and retained.

 

 

Treas. Reg. §25.2512–5(d)(2)

 

It is considered a federally taxable gift, and a gift tax return should be filed.

As we have established above, in most cases you are transferring value to them, and if that valuation is over the annual gift tax limitations, you have a gift tax return filing requirement for the year in which you made the transfer.

 

Treas. Reg. § 25.2511-1(h)(5)

 

Your child’s creditors may come for your property.

By adding another party to title in some states, you may open up the property to more creditors who may have a claim against your child currently or in the future. You may find out, through a divorce proceeding, a tax issue, or a creditor issue, that creditors have a claim to your house. In some cases, creditors can foreclose on the home and have the right to receive the child’s fractional share.

 

You are giving up a portion of your primary residence capital gains exclusion.

Selling your home, after adding your child to title, means that you can only utilize your primary residence capital gains exclusion of $250k (single) or $500k (married) on your fractional share of ownership. And upon sale of your residence, each child could end up having a long-term capital gains tax bill if the home is not their primary residence.

 

Full Step-Up in Basis Still Possible When Adding Individuals to Title—But Often Missed by Tax Practitioners

Adding individuals to a property title can still allow for a full step-up in basis at death, though it’s frequently overlooked. According to IRC 1014 (income tax code) , the basis of inherited property is its fair market value at the decedent’s death, provided it wasn’t sold or otherwise disposed of before then. Under estate tax laws, IRC 2036 (estate tax code) includes property in the gross estate if the decedent retained the right to use it. This inclusion triggers IRC 1014’s step-up in basis.

Moreover, IRC 2040 (estate tax code) stipulates that the gross estate includes the value of property held as joint tenants with right of survivorship, unless the other joint tenant can prove they originally owned the property. Without adequate consideration for adding someone to the title, 100% of the property’s value is included in the gross estate. However, in practice using our example above, only a proportional share (e.g., one-third) often receives the step-up in basis. The interplay between the assets being included for estate tax inclusion is often missed, but a critical issue for determining the correct basis for income tax purposes.

 

Aligning Heirs and Understanding Tax Implications Before Title Changes

In summary, maybe adding individuals to title can serve your tax needs, but other issues such as family dynamics can influence a lot of things that make this an unideal scenario. To ensure that you and your heirs achieve optimal outcomes and prevent unexpected issues, it’s critical to keep everyone informed and include them in tax discussions with your tax professional, as well as in legal discussions about property ownership and inheritance with your legal advisors.

James Yochum's post Hidden Dangers of Adding Children to Your Home Title: Avoid Costly Tax Mistakes Now! was written for Corridor Consulting - Certified Public Accountants - Iowa.

In the complex and often emotional journey of managing a deceased loved one’s estate, few tasks are as critical and revealing as pulling tax transcripts. A recent interaction I had with another tax professional sheds light on the indispensable value of this practice, especially in today’s economic landscape where assets can easily remain hidden, leading to unexpected tax implications for personal representatives and beneficiaries.

The Spark: An Unexpected 1099-INT

The inquiry from their client started with a call about receiving a 1099-INT form for the 2023 calendar year, issued in the name of his mother who had passed away in 2020. Although he hadn’t received any funds since a refund in 2021, the appearance of this form under her Social Security Number raised both confusion and concern. The lack of recent financial activity suggested the possibility of an unclaimed refund check. Cashing such a check becomes a challenge if the estate’s bank account has already been closed, necessitating the reopening of an account—a process that involves providing the SS-4 form for the estate’s EIN, setting up debit card passwords, and more, all for the sake of depositing and then closing the account again after the check clears. To avoid these complications, we focus on proactively tackling the underlying issue at the earliest opportunity.

The Root of Surprise Tax Forms

This scenario isn’t uncommon. Assets, often forgotten or unknown, can surface years after a decedent’s passing. With interest rates on the rise, even dormant accounts can generate enough interest to necessitate a 1099-INT. For those managing estates, such surprises can not only be a logistical hassle but also rekindle emotional turmoil. In this case, the possibility is an outstanding refund from prior tax year’s was still processing. Another issue is the impact on retroactive tax laws, or IRS administration giving forms of penalty relief such as Notice 2024-7: Relief from Additions to Tax for Certain Taxpayers’ Failure to Timely Pay Income Tax for Taxable Years 2020 and 2021. If the IRS has been processing a refund and has not sent payment, due to administrative delays they owe the decedent interest. It is common this happens in estate’s especially as individuals age there maybe issues with prior returns, that delay refund processing. So the question in this case, was is this common? And if so what can we do to navigate these risks for clients.

Why Pull Three Years of Transcripts?

At Corridor Consulting, our approach is proactive. We pull three years of transcripts for every deceased taxpayer we work with. This practice isn’t just about diligence; it’s a discovery process. Beyond identifying outstanding refunds or processing errors, transcripts reveal unreported accounts and assets that the attorney, personal representative, and beneficiaries might not know exist.

A Real-World Example

Consider the son above receiving a 1099-INT in 2023 for his mother who passed in 2020. In this case it is likely transcripts would have offered clarity, showcasing outstanding refunds and alerting us to issues that might otherwise remain obscured. At Corridor Consulting we have seen many examples in our time working on Estates & Trusts that pulling transcripts would have helped prevent issues in the future – so that is what we do now for every decedent.

The Value Proposition

Facing the prospect of hidden complications, some might question the cost of pulling transcripts. Our response is straightforward: the initial investment in ensuring a clean, issue-free estate far outweighs the potential costs and headaches of untangling unforeseen tax problems down the line.

At Corridor Consulting, we’ve adjusted our fees to reflect this essential service, finding that clients appreciate the foresight once they understand the potential for future complications.

Beyond Assumptions: A Professional Standard

The resistance some might feel towards pulling transcripts, viewing it as unnecessary if a prior year’s 1040 is available, overlooks a critical reality. Wage and Income transcripts can unveil a wealth of information that wasn’t included—or was purposely omitted—on the decedent’s filed returns. From undisclosed crypto transactions to accounts opened in moments of clarity by individuals with fading memory, the stories these transcripts tell are invaluable.

Conclusion: Making the Unknown Known

The lesson from our experience, and our fellow tax professional client’s unexpected 1099-INT, is clear. Pulling transcripts for decedents isn’t just about due diligence; it’s about uncovering the unknown and ensuring those managing estates are fully informed. It’s a practice that Corridor Consulting champions, not only to prevent surprises but to provide peace of mind in a process that is inherently fraught with emotional and financial complexity.

James Yochum's post Unveiling Hidden Estate Assets: Tax Transcripts for Decedents was written for Corridor Consulting - Certified Public Accountants - Iowa.

Gift and estate taxes along with the generation-skipping tax are transfer taxes on gratuitous transfers of wealth.

These taxes operate quite independently from the income tax code. At some level they interact in important ways, but in general they are poorly integrated with each other. With an obvious gap in the income tax code excluding the value of property acquired by gift, bequest, devise or inheritance the taxation of gifts and estates was to fill that gap. However in recent years the exclusion and exemptions have made these taxes less impactful to taxpayers.

In general a gift or bequest is a transfer of property but because the transferor (person giving the gift) received no consideration in a legally recognizable form, it’s not treated as a sale or exchange that would be taxed for income tax purposes. So a donor (in the case of a gift) or a decedent (in the case of a bequest made at death) generally do not have to recognize gain or loss upon the transfer of property by a gift or bequest via a will on their personal income tax return, or final income tax return at death respectively.

There is no statutory provision preventing a gift or bequest from being treated as a taxable event. Congress has the power to change this in the future.

In fact there has been proposals to treat a gift or bequest of property to cause the transferor (person giving the gift, or decedent making the bequest at death) to realize gain or loss upon gift or bequest. But these efforts have largely been ignored and this treatment has prevailed for an entire century ( since 1913).

There are several cases where a gift can be treated as a sale or exchange, and you would have a gain.

A common example is if a gift is given that has liabilities attached to it, in excess of the donor’s basis (typically original purchase price). For example, you gift a house you bought for $100,000 in 1980, that has a mortgage of $150,000, and is worth $500,000 in 2022. If you gift that house to your children, with them assuming the mortgage you have a recognizable gain of $50,000, and a gift of $350,000. This is because the Internal Revenue Services views this as though you’ve received partial payment for the property. There would most likely be no realizable gain (Gain on which tax is due) due to IRC 121, which permits a married couple to exclude up to $500,000 in gain from taxable income or a single individual up to $250,000. If you decided to gift only the house, and keep the mortgage (requires approval of the lender), there would be no gain, and it would be considered a full gift of $500,000. What if the house was purchased for $700,000, and there is a mortgage of $550,000 and its fair market value is $500,000? If you gift the house and let them assume the mortgage, it’s a deemed sale of $550,000, and you have incurred a loss on the sale of personal-use property, which is not deductible.

Another example is If the gift is conditioned on whether or not the donee (person receiving the gift) will pay the donor’s (person giving the gift) gift tax liability which is known as a “net gift”. This is because the IRC looks at the intent of the agreement to discharge the transferor of a liability I.E another person agreeing to pay the liability (even if the transferor is in-fact still liable legally).[3]

Lastly, a lifetime gift of an installment obligation is treated as a taxable disposition that then accelerates built in gain in the donor’s hands [4].

• For example: Say Andy sold a Home on an installment sale basis for $60,000, which cost him $30,000, he accepted a $10,000 down payment and an installment obligation at 6% APY interest amortized over 30 monthly payments of $1,795/month.
  
• The face value of the obligation is $1795*30 months =$53,850. The gross profit ratio is 50%, on the principal received each month, the first payment consists of $1,551.98 in principal, and $243.38 in interest. For tax purposes 50% of the principal or $775.99 is realized capital gain taxed at 0%/15%/20%, and the $243.38 in interest is considered ordinary income taxed at the marginal income tax rates.

• If Andy decided to gift his son the installment obligation before receiving any payments, the full unpaid principal balance of $50,000 ($53,850-$3,850)(30 months of interest)) less the remaining income (gain) returnable to the holder of the agreement (50% gross profit margin * $50,000 =$25,000) equals a basis in the obligation of $25,000, any payment in excess of $25,000 will result in a taxable gain to Andy. If the FMV of the note is $50,000 at the time of the gift, Andy would be deemed to have gifted $50,000 to his son, and per IRC 453, would have a deemed disposition with a gain of $25,000 ($50K FMV-$25k basis)

In very rare cases a decedent would realize a gain or loss in property owned at death.

In the case of a Self-Cancelling Installment Note (SCIN) the built-in gain would probably be taxed to the decedent’s estate (instead of the decedent on his or her final income tax return) [5]. However it’s important to note, that legal jurisdiction can come into play in making this decision as the tax court [6], and district courts have been at odds as to what I.R.C. section is the controlling provision as two of them are at odds with each other.[7]

The exemption for gifts is indexed to inflation and for 2022 is $16,000 per person (per spouse) or $32,000 per person for a married couple (gift splitting).

In terms of gift tax exemptions, for 2022 it’s possible to gift to individuals or businesses up to $16,000 with no gift tax return requirement. However, gifts of future interest below the exemption(s), or gifts in excess of $16,000 or a married couple who is gift splitting up to $32,000 would need to file a United States Gift (and Generation-Skipping Transfer) Form 709. A married couple may not file a joint gift tax return. Should a married couple decide to split gifts, they would each need to file separate gift tax returns.

Gifts in excess of the yearly inflation indexed gift tax exemption, are taxable to the extent the taxpayer doesn’t utilize their lifetime GST exemption, for 2022 this exemption is $12.06 Million.

You are not required to allocate your available lifetime exemption. You may allocate some, all, or none of your available exemption, as you wish, among the gifts you make for that year. If you do not allocate your exemption, you will be subject to gift tax rates.

2022 and 2021 Federal Gift Tax Rates

If you need any help regarding these issues Corridor Consulting would love to help, please schedule an individual consultation here. We’re looking forward to opening many more doors for you!

If you found this article helpful and enjoyed it please share it with others and join our newsletter below

This article is not professional tax or legal advice for your specific circumstances. Consult with your professional adviser to better understand how these items may impact you, or how they’ve changed

[1] I.R.C §61 (a)

[2] I.R.C. §102(a)

[3] Reg. 1.1001-2(a) & (c) (example 6) & Diedrich v. Commissioner, 457 U,S, 191 (1982)

[4] I.R.C. §453B(a)

[5] I.R.C. §453B (c) and (f)

[6]Estate of Frane v. Commissioner upheld unrealized gain is reported on decedents final Form 1040

[7] United Stats Court of Appeals for the Eight Circuit reversed the Tax Court holding on the issue, and held that the gain is reported on the estate tax return, on the theory that I.R.C 691(a)(2) and 691(a)(5) are controlling provisions.

James Yochum's post Is Giving a Gift or Inheritance of Property, Taxable? was written for Corridor Consulting - Certified Public Accountants - Iowa.