Potential Tax Implications in Adding Someone to a Deed
A. Loss of Step-Up in Basis
The sale of a home can trigger the imposition of capital gains tax on the seller. The amount of tax owed is based on difference (the gain) between how much the house was purchased for (with the addition of money spent on capital improvements) versus how much the house is sold for.
US tax law has a loophole whereby the value of a property is “stepped up” in basis when property is inherited after the death of the owner. That means when someone inherits certain assets (including real estate), the IRS resets the basis of these assets to their market value on the date of the original owner’s death. Then, when the heir sells these assets, capital gains taxes are calculated only on the sale price that is above this (usually much higher) stepped-up basis. This “step up” in basis only occurs when an owner dies, so by adding someone to the deed, the heirs of the owner are deprived of the benefit of the full step up. (If you gift property, you also gift your then-current basis in the property.)
It is worth noting that there is a significant exemption available for the sale of one’s primary home (currently, you can sell your primary residence and avoid paying capital gains taxes on the first $250,000 of your profits if your tax-filing status is single, and up to $500,000 if married and filing jointly). However, to qualify for the exemption, the property must have been owned and used as the seller’s main home for a period aggregating at least two years out of the five years prior to its date of sale.
B. Gift Tax
A gift tax is a federal tax imposed by the IRS on individual taxpayers who transfer property to someone else without receiving anything of substantial value in return. This includes adding someone to a deed without asking for any payment.
The IRS limits how much you can transfer to someone as a gift without the filing of a gift tax return (form 709). Any amount over this threshold ($17,000 in 2023) must be reported and chips away at a combined gift and estate tax exemption ($12.92 million in 2023). Once you exceed this limit (i.e. gift away more than the exemption, either through lifetime gifts, or the gifts you make through your estate plan after your death), the gift and estate tax becomes payable.
Because of the very high lifetime gift tax exemption, most people do not have to be concerned about paying gift tax when they add someone to a deed. However, because there is no guaranty that the gift tax exemption limit will stay the same over time (it is set to drop to about $7 million in 2026), it is still best practice to complete a gift tax return the year in which the transfer occurs, and to make sure you’ve thought through the consequences before making a large gift.
C. While Probate can be Avoided, Inheritance Tax Can Not Be Avoided (although they can be reduced)
Many times when someone seeks to add a person to a deed, rather than dispose of property via estate planning, they do so with the assumption that probate (the formal process of raising an estate) and associated inheritance taxes can be avoided. It is, unfortunately, not quite that simple.
It is true that by adding someone to a deed with Right of Survivorship – if you add them as Tenants By the Entirety (for married couples) or Joint Tenants (for anyone) - you can ensure that property passes automatically to that person upon your death, without the need for probate for that particular asset. If you add a person as Tenants in Common, however, probate will still be needed to transfer your remaining interest after your death.
Related to PA inheritance taxes, jointly owned property (even with right of survivorship), as long as it was made joint more than one year before death is taxable to the extent of the decedent’s fractional interest in the joint property. This means that if two people own a property as Joint Tenants With Rights of Survivorship, the surviving person will owe inheritance tax on the ½ interest they inherit when the other person dies, calculated at the applicable tax rate (0% between spouses, 4.5% on inheritances passing to lineal descendants, 12% to siblings, 15% to others). If the inheritance tax is not paid at the time of death, the Commonwealth can still assert its right to payment later and a title company will not insure a sale if there is outstanding inheritance tax due.
For example, if you add a grandchild to your deed as a joint tenant with the right of survivorship, and they survive both of you, inheritance tax would be due in the amount of 4.5% of the ½ interest in the property that they inherited at that time. Note that in a similar hypothetical in which you did not add your grandchild to the deed, but instead left it to them in your Will, they would still owe this 4.5% tax, but would owe it on the entire value of the house that they were inheriting.