As I have discussed in the last few columns, many people have been told they should avoid probate. Uniformly, the reason given is the fear of what probate will cost.
There may be good reasons to transfer assets to your loved ones in a way other than probate (something I will discuss in a future column). However, it is critical to do so in the proper way. The shortcuts I often see are risky and, ironically, sometimes more costly.
Take the example of parents who sign the deed for their home over to one of the children. When the parents die, that child can sell the home and split the money among all of the kids. They avoided the cost of probate!
But they did not really avoid the cost; they delayed it. And when it comes time to pay, the cost may be much higher.
That cost will be due when the home is sold. At that time the home owner (now, the child) will be responsible to pay taxes on the profit from that sale. So what is the “profit”? It is the increase in the value of the home from the time the parents bought the home to the time it was sold. If the home was purchased for $50,000, and decades later is sold for $150,000, that child would end up paying taxes on $100,000!
However, had the parents passed on the home through probate, no taxes would have been due. This “short cut” to avoid probate will end up costing the family many thousands more than if the parents had simply passed on the home (or its proceeds) through probate.
So far, I have explained only the financial cost of this short cut. These parents also broke my first rule of estate planning. They gave up control over their assets. In my next column, I will explain the risks of giving up control, including a risk that may not be so obvious.
© 2016 Steven J Wright