Giving your house to your children can have tax consequences, but there are ways to accomplish it tax-free. The best method to use will depend on your individual circumstances and needs. It’s also important to use a strategy that will put you in the best position for future Medicaid long term care benefit eligibility should the need arise.
Leave the house in your will
The most common way to give your house to your children is to leave it to them in your will. As long as the total amount of your estate is under $5.49 million (in 2017), your estate will not pay estate taxes. In addition, when your children inherit property, it reduces the amount of capital gains taxes they will have to pay if they sell the property. Capital gains taxes are taxes paid on the difference between the “basis” in property and its selling price. If children inherit property, the property’s tax basis is “stepped up,” which means the basis would be the value of the property at the time of death, not the original cost of the property.
There are some downsides to this plan. If you were to need Medicaid at any time before you died, Medicaid might put a lien on the property and the property might need to be sold after your death to repay Medicaid. In Texas, under current Medicaid regulations, a lien on the property by Medicaid can be avoided if the property is your homestead and if it is deeded by the use of an enhanced life estate (“lady bird”) deed to your heirs.
Gift the house
When you give anyone other than your spouse property valued at more than $14,000 ($28,000 per couple) in any one year, you have to file a gift tax return. But you can gift a total of $5.49 million (in 2017) over your lifetime without incurring a gift tax. If your residence is worth less than $5.49 million and you give it to your children, you probably won’t have to pay any gift taxes, but you will still have to file a gift tax return.
The downside of gifting property is that it can have capital gains tax consequences for your children. If your children are planning to sell the home, they will likely face steep capital gains taxes. When property is gifted it does not receive a step up in basis, as it is when it is inherited. When you give away your property, the tax basis (or the original cost) of the property for the giver becomes the tax basis for the recipient.
In addition, gifting a house to your children can have consequences if you apply for Medicaid within five years of the gift. Under federal Medicaid law, if you transfer assets within five years before applying for Medicaid, you will be ineligible for Medicaid for a period of time (called a transfer penalty), depending on how much the assets were worth.
Importantly, some states (such as Texas) allow the use of an enhanced (or “lady bird”) life estate deed transferring the house at death, which is revocable and therefore does not count as a gift under Medicaid rules. Also, the property’s tax basis is “stepped up” for the purpose of calculating capital gains taxes.
Sell the house
You can also sell your house to your children. If you sell the house for less than fair market value, the difference in price between the full market value and the sale price will be considered a gift. As discussed above, you can use the $14,000 annual gift tax exclusion as well as the $5.49 million (in 2017) lifetime gift tax exemption on this gift. The same issues with gifts discussed above will apply to this gift. In general terms, for every $5,000 gifted to your children within 5 years prior to a Medicaid application, the gift will result in a penalty period delay of approximately 31 days for Medicaid eligibility. During that time, Medicaid will not pay for your care.
Another option is to sell the house at full market value, but hold a note on the property. The note should be in writing and include interest. You can then use the annual $14,000 gift tax exclusion to gift your child $14,000 each year to help make the payments on the note. This can be tricky and you should consult with your attorney to make sure this won’t cause tax problems.
However, there are two Medicaid eligibility problems with this approach. First, unless you plan to sell the note in the event of a Medicaid benefit need, you will have an illiquid asset which may make it difficult or impossible to qualify. Second, each $14,000 gift may trigger a penalty period as described above.
Put the house in a trust
One other method of transferring property you might consider is to put it into a trust. If you put it in an irrevocable trust that names your children as beneficiaries, it will no longer be a part of your estate when you die, so your estate will not pay any estate taxes on the transfer. The house will also not be subject to Medicaid estate recovery.
However, transferring the house to the irrevocable trust will count as a gift of the entire value of the house for Medicaid purposes and will trigger a penalty period if you apply for Medicaid within five years of transferring the house. Additionally, once the house is in the irrevocable trust, it cannot be taken out again. Although it can be sold, the proceeds must remain in the trust. If you do not have sufficient assets or private insurance to pay for long term care, this can be a very dangerous strategy with regard to potential future Medicaid eligibility.
In Texas, there is no need to dispose of your homestead for Medicaid eligibility purposes. The homestead of a married couple is an exempt asset regardless of value and the homestead of an individual is exempt up to $552,000 under current Medicaid regulations.
The best way to pass property to your children will depend on your individual circumstances. Talk to the attorneys at JHS to decide what method will work best for your family.