Don’t strike out transferring your home to children. There are much better options than outright transfers that you should consider if you are thinking about transferring your home to protect it from the cost of long-term care.
It’s no secret – I’m a big baseball fan. Tonight, my Pittsburgh Pirates take the field at PNC Park in Pittsburgh to take on the San Francisco Giants in the National League Wild Card Game. Last year, the MLB rules changed to allow a second wild card team from both the American and National Leagues into the playoffs. Usually, baseball teams play a series against each other consisting of a number of games. The Wild Card game, however, is a single win or go home game. The team who emerges victorious tonight has a date with the Washington Nationals in the National League Division Series. The team who loses goes home disappointed.
The stakes are high. In fact, that’s an understatement – the stakes are astronomically high.
The importance of the Wild Card game tonight got me thinking about a different high stakes decision often faced by my clients. Often, I’m asked – should I transfer my home to the children?
In the spirit of baseball, I want to describe three ways that outright transfers of property to children are generally a swing and a miss. Combined, of course, they form a strike out.
Strike 1: Failure to Reserve Life Estate Interest
When you make an outright transfer of your house to children, it means that they become the new owners of the property. Deeds can be written, however, to also convey a life estate interest to the person signing over ownership to their children (the parent in this case). The conveyance language in the deed can specifically create this right by listing the parent as a grantee for the term of their life only.
Reserving a life estate is important. Failure to do so can be a major swing and miss because if a parent makes an outright conveyance to their children without this reservation, the children could decide to kick their parents out. As nasty as this sounds, it has happened in the past and before making any conveyance the grantor (parent) should understand the potential consequences of their actions.
Another option is to use an irrevocable trust. The trust becomes the owner of the property instead of the children. Properly drafted, a trust will include language that allows the parent to live in the home for the rest of their life as well.
Strike 2: Divorce & Exposure to Children’s Life Circumstances
Another pitfall to an outright transfer of the home is that when it is transferred to the children it is then potentially exposed to their life circumstances.
Things change in life. What seems like a good marriage today may not be good tomorrow. Someone who seems financially secure could develop a gambling habit or accumulate serious debt.
Although we may think that these issues will never befall our children, it’s best to protect ourselves ahead of time.
Again, there are tools available to help us accomplish our goals and protect the home from children’s life circumstances. While an outright conveyance to the children is risky, an irrevocable trust will protect the home because the trust and not the children is the owner of the property.
Strike 3: Capital Gains
One of the worst outcomes in baseball is a batter looking at a called third strike. It makes the batter seem like they were either unprepared or fooled by the pitch. I don’t want that to happen to you or your family because of an outright conveyance of your home to the children.
When most of us sell our home, we benefit from a tax exclusion on capital gains we make on the sale. This is because we meet certain ownership and use requirements as set forth by the IRS and we are excluding $250,000 (single person) or $500,000 (married couple) or less of gain.[i]
The issue arises where the property is transferred to the children and they do not live at the property and therefore cannot satisfy the use test. If they are the owners and they sell the property, they will have to pay tax on the gain. Worse yet, they do not get a step-up in basis to the date they took over ownership of the property and so therefore they inherit your basis. If you’ve lived in the home a long time and it has significantly appreciated in value, this can be a significant issue.
Unfortunately, far too often these transfers are made without taking capital gains into consideration.
Once again, irrevocable trusts are a great way to avoid this issue because when a trust is properly drafted, the children inherit the home and therefore get a step-up in basis under the IRS rules.
How You Can Hit
The good news here is that you can plan ahead to avoid these pitfalls while still accomplishing your goals. It is not recommended that you step into the batter’s box alone on this. You should enlist the services of an attorney who is knowledgeable and will explain the various consequences and strategies involved in transferring your home to you.
At Marshall, Parker & Weber our attorneys counsel clients on these and many other issues regarding estate and special needs planning, asset protection and long-term care planning, and life care planning. If you are interested in setting up a free initial consultation with myself or one of the other attorneys at Marshall, Parker & Weber you can use the contact information provided on our website.
If you’re a baseball fan, I hope you enjoy the rest of the playoffs! If you’re a Pirates fan – Let’s Go Bucs!
[i] You can read more about the IRS rules at http://www.irs.gov/publications/p523/ar02.html#en_US_2013_publink1000200711.