[From time to time, it’s good to readdress important topics and so we will rerun past articles. With the real estate market heating up, it was time to bring back an article on reasons not to gift property to your children.]
Reasons Not To Gift Real Estate
With the rising cost of long-term care, families are starting to look more and more at planning for Medicaid to handle those costs. Unfortunately, this has led to a lot of ad hoc transfers based on folk remedies that rarely work out exactly the way they were intended. One of the biggest and most costly mistakes is outright transferring a house to a child or children when other techniques would be much more effective. There are many reasons why an outright gift is not necessarily the best technique, but here are three of the biggest:
- Real Estate is Placed in Jeopardy: Unfortunately, simple solutions can sometimes lead to the biggest problems. When gifting a house to a child, the house becomes owned by the child and therefore is subject to creditors, divorcing spouses, and lawsuits. Someone once told me of how his parents gifted their home to his wife in order to avoid having a Medicaid lien placed on it should they need long-term care. They didn’t transfer it to their son because he had a business and some potential lawsuits and creditor issues, so gifting it to his wife would avoid those vulnerabilities. They didn’t count on their daughter-in-law leaving their son, and then turning around and kicking them out of their own home. The right kind of Irrevocable Property Trust could have taken the house out of their hands for Medicaid Planning purposes and placed its management in the hands of their son, but at the same time, it would keep the house protected from their son’s personal or business liabilities.
- Loss of Tax Benefits: Believe it or not, there are actually tax benefits to the beneficiaries when someone passes on owning real estate. This is principle probably best illustrated by an example. Mom and Dad buy a five-bedroom house on one acre for $50,000 in 1970. As mom and dad get older, they grow concerned about long-term care and gift their house to their daughter in 2018 when the house is now worth $350,000. Mom and dad both pass on in 2030 when the house is now worth $450,000 and the daughter sells it for exactly that. After the sale, she now has $400,000 subject to capital gains, and at 15% that means a $60,000 tax bill. By gifting the house to their daughter, they also gifted their extremely low-cost basis. If instead, they had transferred the house into the same type of Irrevocable Property Trust mentioned in the first example with the daughter as trustee, mom and dad would not have had enough control over the real estate for Medicaid to lay any claims to it, but it would have been controlled enough by mom and dad under tax laws that the cost basis gets “bumped up” to fair market value on the date of death. So now daughter could sell the house for $450,000 with NO capital gains taxes.
- Inheritance Plans Thwarted: Life doesn’t always go as planned. If mom and dad give their house to their son to avoid it being counted in Medicaid equations, and then they pass on, it may satisfy their estate planning wishes. But what if their son dies in a car accident? What happens to their house then? If the son’s estate plan had his wife inheriting his estate, then mom and dad’s house now belongs to their daughter-in-law. What if there wasn’t enough life insurance to support her and the young kids? What if they need money for college? Do you really expect a mother to choose between her own children and her deceased husband’s parents? And what if she decides to remarry? Will the house actually go to their grandchildren as they wished, or will it instead be inherited by their daughter-in-law’s second husband and eventually end up in the hands of his kids?
Again, all of these horrific possibilities can be avoided by putting the house into the right Irrevocable Property Trust. If mom and dad had named their son as the trustee and named their niece as the backup trustee, if their son passed on in a car accident then their niece simply steps in and manages the trust. In addition, all of mom and dad’s estate planning wishes can be incorporated into the right irrevocable trust (or trusts) along with different contingencies. But once a house is gifted, these wishes may go by the wayside.
While it may seem simple to just deed a house to the kids to keep it from being jeopardized by nursing home costs, it can bring along a lot of other problems that can be solved through other techniques. To find out more, please check out our YouTube channel at www.YouTube.com/nclawyer in the Medicaid Planning playlist.