Many seniors consider transferring their homes to children to protect it from long term care costs . This do-it-yourself strategy may accomplish one goal while creating a litany of other problems. . .
1. If the house is sold during your lifetime, your children will owe tax on the capital gain. Under the Internal Revenue Code Section 121, each individual may exclude the first $250,000 ($500,000 for married couples) in capital gains on the sale of a primary residence in which they lived two of the last five years. For example, mom and dad purchased their home thirty years ago for $100,000. Today it is worth $500,000. Disregarding improvements, the capital gain is $400,000. When mom and dad sell their home they will not owe any tax due to the $500,000 capital gains tax exclusion. If they give their house to their children and their children sell the house, the children will owe capital gains tax on the $400,000 gain. This might cost the family as much as $120,000 (30% of $400,000).
2. Your children will lose the step up in basis. Most assets receive a “step up in basis” upon death. In other words, using the example above, if one were to pass away while owning her home the purchase price (cost basis) is no longer $100,000 for tax purposes. It is now the fair market value on the date of the individual’s death (the basis has “stepped up”). Again, we are disregarding improvements to make it easier to explain. Using the foregoing assumptions and assuming the home is worth $500,000 on the date mom dies, if mom owns the house on her death, the cost basis for tax purposes is $500,000. If the children sell the home soon after mom passes away they will likely receive the fair market value of $500,000 and owe nothing. If, however, the house were transferred to them during mom’s lifetime, the children would owe as much as $120,000, as in #1.
3. You are jeopardizing your asset due to unforeseen circumstances in a child’s life. After transferring the home to children, it is owned by those children regardless of the fact that everyone still refers to it as “mom’s home”. You are subjecting that asset to your child’s creditors, divorcing spouses, or litigation.
4. You are jeopardizing your asset if one of the children is not so honest or very desperate. Once again, the home is now owned by your children. If they need cash, they can borrow against the home, leaving you with less money when you need it.
5. You are jeopardizing your asset if your child predeceases you. If your child owns your home and dies before you, his/her Last Will and Testament will determine where that asset goes. If he/she is married, your asset may end up belonging to your son-in-law/daughter-in-law. If not married, it might go to your child’s friends!
How does one protect the house then? There are two predominant methods which elder law attorneys often use – reserving a life estate for the parent or transferring the home to an irrevocable trust. Either method is preferable to an outright transfer but should only be used with the proper guidance of an experienced elder law attorney.