A Risky Proposition: The Pitfalls of Gifting Your House to The Kids
Oftentimes, in lieu of having a lawyer prepare a full estate plan, parents may consider simply deeding their home to their children. There are numerous reasons why a person may believe this is a safe approach: it’s easy; it saves in the short term on legal costs; it avoids the probate process for the house; it saves on inheritance taxes; and it helps them qualify for long-term care benefits. Although these are fine goals, this kind of self-help approach very often backfires.
It is important to understand the risks of transferring your home to your children. Consider the following:
1.) Your Home Becomes Subject to Your Children’s Life Circumstances
Once you sign a deed transferring title of your property to your child, you are no longer the owner. A loss of control of the property comes with this loss of ownership. If any of your children have creditors, a lien could be placed on your property by those creditors. If a child is in an accident and does not have sufficient insurance, your home could be subject to a lien or sale. Moreover, the house can no longer be protected by Massachusetts’ generous Homestead laws (up to $500,000) because the resident (you) no longer has a titled interest.
Also, if a child divorces, the ownership interest in your home may become part of that divorce settlement. Likewise, if your child passes away before you, the home will be distributed to their estate beneficiaries. The beneficiary could be someone whom you do not get along with, and they could go so far as to take action to evict you!
Your children’s lives may appear stable today, but it is impossible to predict what may happen in the future, and too important to risk. The risk of losing the ability to live in your residence is too large gamble to take.
2.) Your Transfer is Subject to the Five (5) Year Medicaid Look-Back
Transferring your home to a child is a gift for Medicaid purposes. Medicaid penalizes gifts made within five (5) years of applying for benefits. During a Medicaid penalty, Medicaid will not pay for long-term care services – you will be disqualified.
Some parents explain that the deed states that they sold the house to their child for “one dollar”, and therefore it is not a gift. However, Medicaid treats any amount under the fair market value of the property as a gift. Unless your house was really only worth one dollar, the full value of the home is going to be considered a gift for Medicaid purposes for five years from the date of the transfer. This could significantly impact your ability to pay for long-term care and in certain circumstances could create a situation where your children become responsible for your nursing home bill under Massachusetts’ filial support law.
Disqualification can be avoided if the home is properly handled as part of a Medicaid Plan, and will be considered a ‘non-countable’ asset.
3.) Your Child May Have Future Tax Gain Issues
Generally, when you gift property, the person that receives the gift receives a tax basis in the property that is the same as the donor’s. When it comes to real estate, that is a painful reality. Your basis is the amount you purchased the property for, plus improvements. For example, if you purchased the property 30 years ago for $60,000, and today it is worth $300,000, the basis you are giving your children is only $60,000. Once you no longer occupy the property and it is sold, your children may have $240,000 in taxable income! (assuming it sells for $300,000 and the children did not make it their primary residence). Ouch!
In contrast, if you retain ownership or use a trust to retain certain control over your real estate during lifetime, you can still pass it along outside of probate, but your children would get a stepped-up basis. This means that your children will inherit the property at its value as of your date of death and there will be zero tax due!
4.) Inheritance Taxes Don’t Affect Most People
If you have considered transferring your house to the children to avoid inheritance taxes, consider that Federal Estate Taxes do not apply to the first $3,500,000 of assets (if you are a married couple with proper planning, make that $7,000,000!), and Massachusetts Estate Taxes do not apply until you cross the $1,000,000 ($2,000,000 for married couples with proper planning) threshold! So there is no tax advantage, and probably a serious tax burden, to be gained by transferring the property outright to your children.
The good news is that you can protect against all of these dangers. There are options, such as irrevocable trusts and life estates, that can alleviate the risks. A properly drafted estate plan can serve to safeguard and secure your home, among other assets, from a majority of the risks associated with an outright transfer.