Gifting Homes to Children Can Be Creating A Gift For the Government

Older adults are often concerned with preserving their homes from long term care costs. For many years, the solution has been to transfer their homes to one or more of their children. Doing so can be perilous for a number of practical reasons including the impact upon property in the event one of these children goes through a divorce, has issues with creditors, or predeceases their parents. On top of these concerns, one should be aware that giving a home to children can be beneficial to the government.

If a house is transferred outright to children, the government may be a beneficiary of this transfer for income tax purposes. Specifically, when a home is transferred outright, the children receive the transfer with what is known as a carryover basis. For example, Mom owns a home worth $400,000. She purchased it for $100,000 and put another $50,000 worth of improvements into the home over the years. Thus, the basis of the home is $150,000. If she transfers her home outright to her children, their basis for eventual capital gains taxation is $150,000. If the children sell the home for $400,000, they will have a capital gain of $250,000. Between federal and state capital tax rates, this may result in capital gains taxes of approximately $50,000. If Mom died owning the home, her basis would get stepped up to its value on her date of death. Thus, if the home is worth $400,000 on her date of death, the basis is stepped up from $150,000 to $400,000. If the home is sold for $400,000, there is no capital gain or capital gains tax.

To avoid capital gains taxes while endeavoring to preserve a home from long term care costs, many have transferred their homes to their children, but not outright. Instead, they transfer their homes with a reservation that they have a life estate in the home. The life estate, in short, retains the parent’s right to continue to live in the home until death. Because of this retained right, the home is counted as part of a parent’s estate when he or she dies for estate and inheritance tax calculations. However, it allows for the property to receive the aforementioned step up in basis upon death. Because many individuals who seek to engage in long term care planning do not have estates which are subject to estate or inheritance taxes upon death, the decision to transfer a home with the reservation of a life estate has often seemed simple.

There have been some risks in this strategy. If a home is sold during lifetime, the property is sold at its carryover basis and is thus subject to capital gains tax. Also, the State imposes an economic value of a life estate and requires that same be paid over to the life tenant and spent on long term care costs in order to obtain or maintain eligibility for Medicaid benefits. If the house is held until the parent’s death, the step up in basis has been received and there has been no payment required from the house, as it has been historically deemed that a life estate has no value at death – until now.

Earlier this year, an Ohio appeals court ruled that a deceased Medicaid recipient’s life estate does not extinguish at death for the purposes of Medicaid estate recovery. (See Phillips v. McCarthy, 55 N.E.3d 20 (Ohio Ct. App. 2016)) Estate recovery is a concept whereby each State is to recover from any assets of a decedent up to the amount Medicaid paid for his or her care during his or her lifetime. In this case, Lawrence Hess transferred his home to his three daughters and reserved a life estate. Eventually, he required nursing care and Medicaid paid for this care for about one year prior to his death. After the State put a lien on his former home, his daughters filed an action to quiet title and discharge the lien.

The appellate court agreed that common law does not value a life estate upon death. It also noted that a life estate was not explicitly mentioned in the federal legislation which mandated that each State create estate recovery acts in order to be able to receive matching federal dollars in which to administer its Medicaid program. However, it asserted that States, not the federal government, set forth the law regarding real property. Thus, it noted that Ohio, in its estate recovery act, included “life estates” as property which may be recovered at death. Whether the calculation of that life estate is made at the time of the gift or the age at the time of death is unclear.

What is clear is that transferring a home – with or without the reservation of a life estate – may be problematic. Before making this transfer, one needs to weigh the potential long term care costs which he or she may be facing with the potential capital gains costs which may eventually be incurred, as well as the amount of the property which may be held for estate recovery. Although New Jersey and Pennsylvania may not be enforcing a lien on life estates at this time, neither was Ohio when Mr. Hess transferred his home to his daughters. The right to collect against a life estate was not implemented until Ohio’s estate recovery act was amended. Thus, caution needs to be exercised in property transfers for long term care planning.


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