It is the heart of seminar season for us here at Marshall, Parker and Weber and soon it will also be health fair season and baseball season (my favorite). What I encounter every year around seminar season and health fair season is that one common question or statement that is repeated day in and day out.
I either get “I transferred my house to my child/children to protect it from nursing home costs, that was the smart move, right?” or “Should I transfer my home to my children? I have heard about this look back rule and I want to protect my house in case anything happens.”
Inevitably everyone wants me to assure them that yes that was the smart plan and good job doing that without talking to a lawyer. Unfortunately, what I tell them is not always what they want to hear and instead of disappointing you, I would like to give you some advice ahead of time before you make that decision to go ahead and transfer your home to your child/children.
The big issue people face when transferring their homes to their children is they do not take into account their children’s life circumstances. Simply put, parents do not think about the worst-case scenarios with their children and what that means for them. Parents do not like to think their child is a gambler or maybe an alcoholic. What seems like a good marriage today may not be a good marriage tomorrow. Accidents happen, health problems may develop and parents may outlive their children. These are issues that mom and dad never truly think about when transferring their house to their children and unfortunately it can come back and hurt them.
However, there are things you can do in order to protect your interest in your home and at the same time protect it from nursing home costs.
One way to protect your home from the costs of a nursing home and still protecting it for you and eventually your children is to put it in an irrevocable trust. This way the trust is the owner of the property with no life circumstances that would cause you to be removed from the property. Moreover, when you die the property will then be distributed to the beneficiaries (who could be the children that you initially thought about giving the house to). This trust allows you to protect your house from those costs of care that you may be concerned about and distributes it to your intended beneficiaries when you are gone.
One thing you must remember when considering a trust is there is a five year look back no matter if you transfer it directly to a child or into a trust. This type of planning should be done some time in advance so you get through the five year look back.
Another issue you should consider when transferring your home directly to your children is that of capital gains. 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 can meet certain ownership and use requirements as set forth by the IRS and we are excluding $250,000 (single) or $500,000 (married couple) or less of a gain. (1)
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 owners and they sell the property, they will have to pay tax on the gain. What is even worse is because you transferred it during your lifetime, your children do not get a step-up in basis to its value when they took over ownership of the property. Instead they receive your tax basis. This means if you have lived in the property for a long time and it has significantly appreciated in value from the original purchase price; it can be a significant and expensive tax problem for your children.
Here again, an irrevocable trust is a great way to avoid this issue because when a trust is properly drafted, the children inherit the home and therefore get the step-up in basis under the IRS rules. (2)
Finally, if you still insist on transferring your house to your children as opposed to locking it up safely in an irrevocable trust, remember to retain a life estate in the property. Reserving a life estate is important; language is placed in the deed that specifically creates this right that allows you to use and occupy the home for the rest of your life.
This language is important because it keeps children from kicking their parents out of the property. The idea of children kicking their parents out to some is ridiculous and heartless but we address it because we see it more than people think. Having a life estate in the property is an option when you want to transfer your property but you do not want the trust. Does the life estate offer as much protection as just having the property in a trust, no but it is better than not doing anything and just doing a straight transfer to the children?
At Marshall, Parker & Weber our attorneys counsel clients on these issues all the time and if this is a topic coming up more and more often between you and your spouse or within your family, it might be a good time to reach out to an elder law attorney and review your options before you make a decision.