But as with any other real estate transaction, it’s important to move past emotion when deciding what will happen to your abode in the future.
Whether you have a cozy vacation cottage, a palatial estate or a sophisticated condominium, drawing up a clear estate plan can ensure your property is distributed in a way that suits both you and your family’s best interests.
“The best place to start the process of passing your home onto the next generation is to have a conversation with your kids about their expectations and interests,” said Thomas Six, a wealth strategies consultant with RBC Wealth Management in San Francisco.
“If you own a vacation home and plan to pass it on, make sure they really want it. If it’s an investment property that has renters in it, ask them if they want to take on the responsibility of being a landlord. If it’s your own home, ask if any of your kids will want to live there after you pass away or if they plan to sell it.”
There are several ways to pass on your home to your kids, including selling or gifting your home to them while you’re alive, bequeathing it when you pass away or signing a “Transfer-on-Death” deed in states where it’s available.
“How you handle your property has both legal and tax implications, so if you don’t do it right, it can become a burden instead of a gift for your kids,” said Lloyd Cohen, a law professor at George Mason University School of Law in Arlington, Va.
Here’s what you should know about each option:
1. Selling your home to your kids
Parents can sell their home to their children, even if the parents plan to continue living in the house, said Six.
“The parents need to sell it to their kids at fair market value—comparable to what other similar properties are currently selling for—because if they opt to do a bargain sale, then that’s partially a gift and will generate tax implications,” said Six.
Parents can loan money to their children to purchase the home, but legally the parents must charge interest to the kids and then declare the interest they earn as income.
“If the kids can afford to buy the home, a sale can be great for parents who want to downsize and need the proceeds of the sale to move,” said Six.
You can opt for a life estate that allows you to live in the property until you pass away. But Six said you must pay fair market rent in order for it to be considered a legal sale.
“Never do a life estate unless the property is land-only without a resident,” said Cohen. “If the person living in a home under a life estate must move, such as to an assisted living facility or just to move in with another family member, that life estate cannot be sold. No one wants to buy a home in which someone else is legally allowed to live until they die.”
Another option is to establish a Qualified Personal Resident Trust (QPRT), said Six, which transfers ownership of the home to a trust.
“The terms of the trust can allow the parents to live in the home rent-free for a certain period of time, but this is an irrevocable trust that cannot be changed,” said Six. If the parents outlive the terms of the trust, the property will be excluded from their estate. If they want to continue to live in the home after the term of the trust ends they must pay fair market rent while living in the home.
Cohen cautions a QPRT may not be for every family. He warns parents should be mindful if there is a falling-out in the family, the kids could evict their parents.
2. Giving your property to your kids
If you want to give your property to your kids, Six said it’s generally better to do so through a revocable living trust. This gives you the option of changing your mind in the future. In addition, Six said you must check your mortgage agreement or ask your lender if transferring ownership of the property as a gift will trigger a “due-on-sale” clause (which would force you to immediately pay your mortgage in full).
When gifting property, Cohen reminds owners if the recipient gets into financial trouble in the future, the property could be foreclosed on and taken out of the family in a bankruptcy.
“It’s usually better to transfer property as a gift after your death because of tax implications,” said Six.
3. Bequeathing your property
Six recommended putting a trust in place with a plan for how you want your property distributed after your death.
“Talk to your family about it first to discuss whether anyone wants to live in it, and has the wherewithal to keep up with the property taxes, insurance and maintenance costs,” Six said. “If no one wants the property, the trust can sell it after you pass away and distribute the proceeds.”
If one heir wants the property and others do not, Six suggested making equitable financial arrangements to compensate, such as leaving additional money to the heir who won’t inherit the home.
4. Deed transfer
Twenty-five states and the District of Columbia allow property owners to sign a Transfer-on-Death deed, said Cohen.
“It works in a similar way to a ‘payable-on-death’ designation for a bank account that people use to transfer assets to their heirs,” said Cohen. “You avoid probate on the property and you can also easily change the designation at any time before you pass away. It’s a great idea, but it’s just not available in every state.”
You can sign a Transfer-on-Death deed for any property located in a state that allows this legal process regardless of whether your permanent residence is in that state.
Given the complications of passing your home onto your kids, it’s best to consult a team of wealth advisors to make sure your decisions are in your best interests as well as the interests of your heirs.
This article was originally published on Forbes WealthVoice.