Transferring title to real estate can have a lot of benefits during the lifetime of the owner, but it also comes with some potential hazards you should know about before signing the deed over.
Moving your real estate into someone else’s name during your lifetime can certainly make things more streamlined and easier at your death, especially (from a logistical standpoint) when the overall strategy involves selling that property after you’re gone. It can also keep the real estate out of reach from potential creditors of yours after you’re gone. But, the overall benefits (sale logistics and avoidance of creditors) must be measured against the cons of such a strategy when determining if this is the right strategy for your family.
Transferring an asset to someone else without an exchange of value (consideration) is considered making a gift for the purposes of taxes. More specifically, it implicates the owner’s lifetime estate and gift tax exemption. Each US Citizen and Permanent Resident has a unified estate and gift tax exemption of (currently) $11.4 Million dollars. That means each person can give during their lifetime, or pass on at death, up to $11.4 Million in assets without being subject to gift or estate taxes. Each person also gets an annual gift tax exemption of $15,000 (or $30,000 for a married couple). That means each person can give away up to $15,000 to as many people as they like without the gift impacting their lifetime exemption. In most cases, the gift of real estate will exceed the annual exemption. When a gift exceeds the annual exemption, the donor must submit an “information return” claiming the amount exceeding the annual exemption from their lifetime exemption. So, by way of example, if you gifted a home worth $115,000 to your child, the first $15,000 would be exempt under the individual’s annual gift tax exemption, but the remaining $100,000 would be claimed against their lifetime estate and gift tax exemption, reducing the lifetime exemption amount from $11.4M to $11.3M total. I know, that’s not a significant change, but it’s worth mentioning anyway. As long as the home is not worth a substantial sum, the gift will not have a significant impact on your lifetime exemption.
Gifts can have substantial capital gains tax implications depending on the value and appreciation of the asset. That’s because gifts result in what’s called a “carry-over basis”. The cost basis is the value at which you acquired or purchased an appreciating (or depreciating) asset. The cost basis is what is used as the starting point to calculate a capital gain (subject to capital gains tax) or a capital loss (subject to gains offset or reduction in tax overall). When an asset is gifted to another individual, the receiving party takes the donor’s cost basis, so the basis “carries over” to the new owner. If the new owner sells the asset, the gain or loss would be calculated based on the original cost basis. If an asset is passed on at death (inheritance), the beneficiary/receiver of the asset gets what is called a “step-up in cost basis”. The “step-up” means that the cost basis for the beneficiary in the asset is its fair market value on the date of death of the previous owner. If the beneficiary sells the asset, the gain or loss would be calculated based on the new cost basis rather than the original cost basis.
For a highly appreciated asset that is likely to be sold immediately, it’s better to pass the asset on at death than to gift it prior to death. The receiver will have a substantially different tax result.
Gifting a large asset like a home can also have a significant impact on the donor’s eligibility for Medicaid long-term care services. Medicaid is a means-tested program that requires poverty-level asset ownership to qualify. Part of their method of evaluating the financial resources of an applicant is to perform a financial audit on the applicant for the five (5) years immediately preceding the date of application (if the application is otherwise eligible) – specifically looking for any gifts that may have been made during that time. If the applicant made a gift (a transfer of an asset for less than fair market value) during that five-year window, the applicant’s eligibility may be penalized based on the value of the gift. The value of the gift is divided by the State’s Medicaid Penalty Divisor ($6,810) to determine the number of months of ineligibility the gift will result in. So, taking the home from the example above, if you gifted a home worth $115,000 to a child within the five-year look-back window, the gift would result in an eligibility penalty of just less than 17 months. That means the family would have to private pay for skilled nursing care for 17 months before Medicaid would start paying.
Some of these risks may be insignificant to your circumstances, but the overall analysis of the implications of gifting a home is worth reviewing prior to giving away such a large asset.