A house is typically one of the most valuable assets someone owns, both financially and sentimentally. It makes sense then that, out of love and generosity, many parents want to give their houses to their children during their lives or pass them down as an inheritance. It’s difficult to imagine that giving your child your family home could backfire, but it might — especially if you do not understand all the pitfalls and benefits.
Passing on a home can be a complicated matter, and doing it at the wrong time, in the wrong way or for the wrong reasons can have significant consequences for both parents and children.
A primary reason someone might think about transferring their house to a family member has to do with Medicaid. Nursing home costs continue to rise, and many people want to be able to qualify for government benefits. In addition, they don’t want to worry that their home may be forced to be sold after they pass away to cover the cost of the benefits they received through a process called estate recovery.
Estate Recovery: Why is Your Family Home Vulnerable?
To begin, it is important to understand that Medicaid is different from Medicare (even though sometimes people mistakenly believe the two are interchangeable). Medicare is a federal entitlement program that provides health insurance for people over the age of 65, regardless of how much money they have. Medicaid, on the other hand, is a federal health insurance program for the elderly, disabled and poor that, among other things, will pay for long-term skilled nursing home care for individuals in need.
Generally speaking, people must be below certain quite restrictive income and asset limits to qualify for Medicaid. In simple terms, once most of your assets are gone, Medicaid will kick in to pay for nursing home care. However, a primary residence with $572,000 of equity in 2018 (or up to $828,000 of equity in certain states that opted for an increased amount available under federal law) is considered a non-countable asset. This means that it is possible to own a home and still qualify for the government to pay for nursing home care under Medicaid.
Upon the death of a Medicaid recipient, each state has the right to recover from the deceased person's estate the amount paid for their care. Because the home is one of the only assets that people are allowed to own and still receive Medicaid benefits, the right to recover benefits from the estate (typically from the sale of the house) is what people mean when they've heard that the state will take the home. (Note that no recovery efforts can be made until after the death of the recipient’s spouse.)
Those worried about estate recovery sometimes consider giving the home away prior to the time they believe they will need nursing home care. But misunderstandings about Medicaid’s complex laws can result in serious consequences.
Beware of the Look Back Period
Before transferring any assets, it’s crucial to understand about the look back period and how it affects Medicaid eligibility. When you apply for Medicaid, any gifts or asset transfers made within five years are subject to penalties. In other words, giving away assets can disqualify you from receiving Medicaid.
Under the current rules, Medicaid benefits are denied if people have given away assets within 60 months of the date of application. This critical time is known as the "look back period." Consequently, it is important to trust that you are healthy enough to stay out of a nursing home for at least five years from when you give away your house (or any other assets). Planning must be done long before any need arises.
But keep in mind, the look back period isn’t the only thing to consider if you want to gift away your family home. The way you set up the transfer of your property is extremely important and also fraught with unforeseen consequences — whether it’s an outright deed, a deed with life estate, or to an irrevocable trust. Here’s a brief review of the pros and cons of each:
- Outright Deed: Giving away your home can be as simple as executing a deed transferring ownership to someone else, such as your child. This is straight-forward and relatively inexpensive to accomplish. However, if the person to whom you gift your house gets sued, divorced or declares bankruptcy, the house can be lost. And, if you arranged to continue to live in the house, that right could be lost as well. Another potential problem is that the people you give away your house to could disagree over how to manage the house, and family fights could ensue.
- Deed with Life Estate: You can also execute a deed transferring ownership, but if you include a life estate in the deed, your right to live in the house for the rest of your life cannot be taken away. While a life estate can solve some of the above issues, the part of the house you've given away — known as the remainder interest — is still vulnerable to creditors and divorce, and to fights among the new owners. In addition, in some states, the life estate may be subject to estate recovery.
- Irrevocable Trust: You can also transfer your house to an irrevocable trust. An irrevocable trust provides protection for the house from the creditors and divorces of the beneficiaries of the trust (other than you — and in some states you can be a limited beneficiary of the trust). In addition, the trust can dictate how the house will be dealt with after you pass. For example, should one child have the right to live there for a period of time? Should any child have the right of first refusal to buy the house? Should the house be sold to a third party? These provisions can ensure that fights among your children about what to do with the house after your death are kept at bay. But while a trust addresses many issues, it is also much more expensive and complex, easily costing thousands of dollars to implement.
Possible Tax Downside of Transferring Property to Your Kids
Capital gains taxes are generally owed when you sell an asset that is worth more than you paid for it. However, individuals can generally exempt up to $250,000 from capital gains taxes upon the sale of a primary residence if they occupy the house as their primary residence for two of the five years prior to the sale. Couples can generally exempt up to $500,000. So, if your home increases in value you might not need to pay capital gains taxes when you sell. If you give your house to your children, and they do not live there as their primary residence, they will not be eligible for this exemption upon a sale. They would need to pay capital gains taxes on the increased value. Proper planning can help minimize or eliminate this result.
Also important is that if you retain certain ownership rights in your house (such as a life estate or possibly through an irrevocable trust), then when you die the tax basis of the house becomes fair market value at death. This is known as the step-up in basis rule, and it’s important when it comes time for your children to sell the home. This rule eliminates any capital gains taxes your children might otherwise need to pay upon the sale of the house after you die.
Needless to say, there are many things to consider before deciding whether or not to give away your house. Tax issues and the complex timing rules for Medicaid can make giving away our house tricky, but with careful thought and planning there are strategies that make it possible to accomplish your goals.
Should you give away your home to family members? Because rules can vary from state to state, it makes sense to consult with a local attorney or estate planning expert before deciding. That way you can pass along your most valued asset to future generations in the best way possible and avoid unpleasant consequences.
Tracy A. Craig is a partner and chair of Seder & Chandler's Trusts and Estates Group. She focuses her practice on estate planning, estate administration, prenuptial agreements, guardianships and conservatorships, elder law and charitable giving. She works with individuals in all areas of estate and gift tax planning, from testamentary estate planning and business succession planning to sophisticated lifetime leveraged gifting techniques, such as grantor retained annuity trusts (GRATs), intentionally defective grantor trusts, family limited liability companies and qualified personal residence trusts (QPRTs). Tracy serves in various fiduciary capacities, including trustee and personal representative (formerly known as executor). She also works with clients on issues facing elders.
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