It’s Not Just A Deed – The Possible Pitfalls Of Transferring The Home To The Children

As parents age and become acutely aware of the potential specter of long term care costs, there is a strong desire to preserve the assets which they have accumulated over the years. The most significant of these assets for many of them is the family home. More often than not, many parents believe that the best solution to this issue is to gift the home to their children.  In the category of “the road to hell is paved with good intentions”, this is often a horrible idea for a host of reasons.  Although the transfer of a home is can be prudent, the manner in which a home is transferred has to be carefully handled.

Specifically,  a number of pitfalls need to be avoided.  They include the following scenarios:

Capital gains taxes

Mom and Dad own a residence which they purchased in 1955 for $15,000.  Over the years, they have put $35,000 of capital improvements into the property.  It is now worth $400,000.  Because Dad has just started to demonstrate the signs of early dementia, the family wants to protect the house in case he has to go to Happy Acres Nursing Home across town.   So after a consult with their friend, Edith, who did some “research on the internet”,  Mom and Dad transfer their home outright to their three children – Manny, Moe and Jack.   Several years down the road, Mom and Dad die.  As the real estate market has increased, the home is now worth $450,000.   However, when filing their personal income taxes the following year, they find out that they have incurred a $400,000 capital gain and that the combined federal and state taxes owed are approximately $80,000.

Nursing Home Costs

Same fact pattern as above.  However, they go see John Doe,  attorney at law, who is the proverbial Jack of all trades.  He transfers the home to the children for them, but retains a life estate for them.   If they die still residing in the home, the capital gains problem from above is avoided.  Five years later, though, Dad has passed away and Mom has to move to Happy Acres because of a stroke.  The children sell the house not wanting to deal with a vacant property.   Because the house has been out of Mom and Dad’s name for so long, the lifetime transfer is subject to capital gains tax as the children don’t use the house as a primary residence.  To add insult to injury, Mom who was on Medicaid, is now ineligible as the State imputes a value of the net proceeds of the home to her.

Creditors

Same pattern as above.  When the house is sold, Jack’s share of the net proceeds goes to a creditor who sued him and obtained a judgment against him.

Student Aid

Same pattern as above.  Moe has a child in college who is receiving needs based financial aid.  Mom and Dad are still  healthy and living in the home.  Moe really doesn’t have any benefit from the home.  Yet he has to disclose it as an asset on his financial need paperwork for his child.  Because of the value of the home, Moe’s child loses her scholarship.

The Solution

The above is just a sample of the issues which arise in transferring a home to children.  One option is to create what is known as a residence trust.  If done correctly, the home is protected from all of the aforementioned issues.   One of the children can be appointed as trustee.  The trustee must be irrevocable.  It can be set up so that Mom and Dad can maintain their income tax rights to the property.  If done properly, it can moreover keep the parents’ exemptions from capital gains tax for a primary residence and obtain a step up in basis upon death.

In all, a house should be protected as it is a sacred asset for many.  Yet it should be done with the proper format and with proper guidance.  If same are obtained, a home can be protected without the above pitfalls.

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