Joe sounded upset when he called us. His mother wanted to protect her home from the cost of long term care so a few years ago she transferred the house to Joe and his sister, keeping a life estate for herself. Now they want to sell the home because his mom needs nursing home care.
We asked a few more questions and Joe explained that his mom has very few other assets, maybe about $10,000. He also said the home transfer occurred more than 5 years ago so it falls outside of Medicaid’s 5 year look back, meaning the transfer would not create a Medicaid penalty. Joe’s hope was that the liquid assets would cover whatever private pay amount that might be owed to the nursing home before transitioning to Medicaid. The proceeds from the sale would then be the inheritance that Joe’s mom wanted to provide for her children.
So what was getting Joe upset? He had a conversation with a friend who said he would have to pay capital gains tax on the sale proceeds. He didn’t quite understand why that could be true since Mom had lived in the home for nearly 50 years. Isn’t there an exclusion from capital gains tax on the sale of primary residence, he wanted to know.
I explained to Joe that there is an exclusion of $250,000 of gain as long as the home was the person’s primary residence in 2 of the 5 years directly preceding the year of sale. “OK, so then my friend was wrong”, Joe responded.
I disagreed with Joe’s statement. The part he was missing is that while his mom continued to live in the home until the time of sale, she no longer owned the home – or at least she didn’t own all of it. I examined the deed and it did indicate that Mom has a life estate which is a legal right to live in the home. That right equates to an ownership interest based on the life expectancy of an 85 year old – Mom’s current age. I told Joe that her share of the purchase price was approximately 25%. Joe estimated that the home would sell $400,000, making Mom’s share about $100,000.
Next week I’ll share with you what the capital gains tax would be and what could have been done to protect the home without having to pay any capital gains tax. I’ll also tell you the other problem Joe wasn’t yet aware of until our conversation.