Don't add a loved one to your deed
We would like to introduce a new columnist, Harvey S. Jacobs, a real estate lawyer and investor based in Rockville. He will write about all aspects of residential real estate law, addressing concerns of buyers, sellers, landlords, tenants and small investors. The Housing Counsel column by Benny L. Kass will continue.
The contexts vary, but the question remains the same. People say they want to add a loved one's name to their deed and want reassurance that it's a good idea. Sometimes the question is asked by an elderly parent who wants to add an adult child or grandchild to the deed in an attempt to make sure the home will go to that person upon the parent's death. Other times it comes from a couple contemplating marriage, and they think adding one person to the deed is a sign of trust and commitment. Sometimes it's posed by a divorced or widowed person who has met a new love.
The answer is simple: It's a bad idea. Don't do it.
When people stop and think about what it really means to add a loved one's name to the deed, most change their minds. What you are doing, in effect, is taking your most valuable asset and giving half of it away -- forever.
Legally, once you add someone to the deed, you have put at least half of your home at risk. If your loved one has a car accident or suffers a financial setback and cannot pay his bills or has a legal judgment entered against him, his creditors can come after your home to satisfy their monetary judgments.
In Maryland, judgment liens against your co-owner automatically attach to your home the minute his name is added to your deed, because his name will be in the public land records as a co-owner. In the District and Virginia, all that is required for this lien to attach is for the creditor to make a simple filing of the judgment in the land records office.
When adding a loved one's name to your deed, you are assuming that your loved one will always love you back. Unfortunately, this may not be the case. And even if the relationship remains sound, other complications can limit your options and threaten your finances.
For example, once you have a co-owner, you cannot refinance your home unless the other person agrees and signs the loan documents. The co-owner's credit score will also be an issue. If it's low, you may have jeopardized your chances of obtaining a loan at a favorable interest rate or terms.
Should you decide to sell, your co-owner would have to sign the listing agreement, sales contract and deed, among other papers. If he were unwilling to do so, you could be stuck paying 100 percent of the mortgage but owning only 50 percent of the home. The only way out of such a predicament is an expensive and time-consuming partition lawsuit.
Adding someone's name to your deed also has serious and adverse tax consequences for both of you.
For those second-time-around lovers who may have built up significant assets, adding a loved one's name to the deed means gifting half the value of that home. Depending on the size of the estate and the value of the home, that gift may trigger state and federal gift-tax obligations. At a minimum, you may be required to incur the cost and hassle of preparing and filing gift-tax returns.
If your goal is to make sure a loved one gets your home upon your death, he probably will be better off inheriting the home rather than receiving half of it as a gift while you are living. In the past, the Internal Revenue Service has allowed heirs to enjoy what is called a "stepped-up basis." That means that for capital gains purposes, your heir can take the fair market value of your home on the date of death as his basis (or acquisition value), and when he sells the home he will pay capital gains tax on the difference between his net sales price and the stepped-up basis.
When you gift half your home, your loved one assumes your basis as his new basis. If you bought your home many years ago, when prices were low, your basis may be very low, and thus when your loved one sells, there would be a much higher capital gain -- and tax.
For example, say someone bought a home for $250,000 and on the date of death, it was worth $650,000. Its value continues to appreciate, and the heir sells it, netting $700,000. Because he inherited the home, the new basis for capital gains purposes is $650,000. Subtract the new basis, $650,000, from the net sales price of $700,000 for a capital gain of $50,000. Because he sold inherited property, it will be taxed as a long-term capital gain with a maximum tax rate of 15 percent. Thus, the heir's tax will be $7,500. On the other hand, if the owner had gifted the home, the loved one would have a basis of $125,000 for the half of the home he had been gifted and a $325,000 basis for the half he inherited, for a total basis of $450,000. When you subtract the $450,000 basis from the net sales proceeds of $700,000, that leaves a $250,000 capital gain, resulting in a tax liability of $37,500. However, for the 2010 tax year, Congress is revisiting these step-up rules.
If you really love someone, name that person in your will and make him wait to inherit your home.
Harvey S. Jacobs is a real estate lawyer in the Rockville office of Joseph, Greenwald & Laake. He is an active real estate investor, developer, landlord and lender. This column is not legal advice and should not be acted upon until legal counsel has been consulted.