Certain activities such as dentistry, tattooing and estate planning should usually be hired out to someone qualified and not performed at home. Few people know enough to do their own estate planning.
One of my clients consulted with Grandma to gift her real estate during her lifetime in order to avoid probate. There are two major problems with this.
Grandma and Grandpa purchased their residence in Washington State on ten acres in the country, 50 years ago. Grandpa passed away 20 years ago, leaving Grandma with a property valued at $300,000, but today, due to growth in the area, the property is worth $900,000.
If Grandma sells the property during her lifetime, her gain is reduced by $250,000 because it is her residence, so the capital gain is $350,000. Before we go further, let’s review that math:
Today’s value $900,000
Value when Grandpa died ($300,000)
Residence exemption ($250,000)
Capital Gain $350,000
If Grandma were to pass away and leave the property to her children, they would claim the step-up in basis and pay no tax.
Problem One: A strange thing happens when property is gifted. The original basis goes along with the property. So if the children received the house before Grandma dies and then sell the property, all of the $600,000 gain is taxed, $900,000 less the original $300,000 basis when Grandpa died.
There is no break for it being Grandma’s residence and no step-up in basis. This mistake cost the heirs about $100,000 in additional income tax.
Problem Two: Probate may not be that expensive or cumbersome in your state. Avoiding probate may or may not be the best strategy depending on the asset mix and the state of residence. Consult an estate attorney on this question.