Should Your Clients Give the House to the Kids?
Theoretically, your clients could give their house to their adult children — and still live in it, of course — and in the process reduce the taxable value of their estate; it’s a win-win.
However, says The Wall Street Journal, there are plenty of potholes along that road paved with good intentions. http://tinyurl.com/lvqqvo3
You can’t pick your family
By transferring ownership of their home, your clients are giving up the security they’ve always had as homeowners.
What happens if your client’s daughter divorces that son-in-law your client is none too fond of? The ex may have a legal claim on half of the home, and the only way he could get his share is to kick your client out and have the house sold. And because the house is no longer in your client’s name, your client would have no legal recourse to prevent it.
Or think of this: Creditors could try to seize the home if an adult child defaults on a loan taken against the house or loses a legal dispute.
Finally, if there’s a falling out between your client and the child. The child might just sell the house out from under your client
These are examples of problems within the family, but there are more things to consider before you transfer ownership of your home.
Can’t win for losing
If your client is looking for the transfer to help him qualify for Medicaid’s long-term care benefits, think again, The Journal says.
When you give away property within five years of applying for Medicaid’s coverage of long-term benefits, the agency figures the gift was given to make your client eligible to qualify for Medicaid. And the governmental program isn’t going to let that happen because, in most cases, your client’s application for benefits will trigger a period of ineligibility. The government figures that a sale of the property could have been used to pay for your client’s care.
It is possible to get around having the house counted in asset valuations, though. The five-year rule doesn’t apply if your client is transferring the property to a spouse or to a child who has been living with your client and providing him nursing care for at least two years.
Less is more
Giving a home away isn’t a great strategy for preserving wealth or to avoid taxes, The Journal says, if the value of a home is within the limit allowed for exclusion by the IRS or state authorities. The gift tax could apply, and there are state taxes to consider.
Instead, the tax hit probably will be less if your client simply passes the house to a child as an inheritance. The heir receives the step-up in basis and can sell immediately with no impact on income or capital gains taxes. Your client also could sell the home and split the proceeds with a child. The first $250,000 in profit is free of capital gains taxes, or $500,000 for a couple.
If giving a home away reduces your client’s estate so much that no estate tax is owed, it’s possibly a good idea, The Journal says. That way, your client may preserve the most assets for a child — even if the child later sells and owes taxes.
Be advised, though, that giving a home away takes away your client’s ability to qualify for a reverse mortgage.
Three other options
If your client wants to continue to live in the house after transferring ownership, other legal steps should be taken — and get professional help in doing so.
One option is to set up a “life estate” where your client pays the child a fair market rent to stay in the home. If rent isn’t paid, the IRS considers your client to have retained interest in the house and treats the transfer as if it never happened. And in that case, the house is includable in estate tax purposes.
Your client also could use a qualified personal residence trust. In this option, transfer the house to a child — through the trust — at a reduced estate and gift-tax cost. And it allows your client to stay in the home for a predetermined period you set yourself. Depending on how long your client plans to stay, the taxable value of the gift can be as little as 25 percent of the current fair-market value of the home. Appreciation in the home’s value then becomes tax free for the trust and the child.
If we’re talking about a large estate, your client can sell or gift the home to a “defective grantor trust.” This freezes the home’s value for transfer tax purposes at its current value, and appreciation during your client’s lifetime happens outside of the estate. This immediately reduces the value of the estate, and appreciation in the home is tax-free for the trust and the beneficiary.
We hope this information was useful to you, your clients and their families. To get more information regarding this or any related topic, please visit our website www.TEPLG.com or call us at 630-871-8778.