Thinking about transferring your home to your children? (Part 2)
Last week I told you about Jamie’s mistake. Mom and Dad transferred their home to Jamie 7 years ago to protect it from Medicaid’s spend down requirements. While the transfer was outside of Medicaid’s 5 year look back, now that Mom was planning to move in with Jamie the tax consequences of the sale of that home had become an issue.
Jamie, as owner of the home, will have a capital gains tax bill of $30,000 to pay because she can’t utilize the $250,000 exclusion of gain on the sale of a primary residence. Jamie and her husband have their own home. So, how could this have been avoided?
Setting up a certain type of a trust and transferring ownership of the home into that trust would have preserved the capital gains tax exclusion. As confusing as it might sound, the home would not have been “owned” by Mom and Dad for Medicaid purposes but they could have preserved the capital gains tax exclusion on the sale of a primary residence, under federal tax code Section 121.
There are other advantages to the trust as well. A transfer outright to a child means the child owns the home. That home is subject to that child’s creditors. If the child divorces, the home could be considered a marital asset and the child’s ex-spouse may be entitled to ½. Finally, if the child dies before the parent the home would pass to the child’s heirs and could be lost to the parent if proper estate planning isn’t done by the child. All that is avoided by placing the home in trust. The home isn’t owned by the child but rather by the trust and is therefore protected.
One final point. You might be wondering why wee would consider transferring the home at all if Medicaid considers it an exempt or not countable asset. Medicaid won’t require the house to be sold before approving Dad for Medicaid. That is true as long as Mom or Dad remain in the home. So often, however, remaining in the home is no longer desirable or safe. If the home is sold and then Mom and Dad rent, the cash from the sale becomes a countable asset and must be spent down. That means at best, Mom would only be able to keep ½ of the proceeds and at worst she might have to spend it all down before Dad is eligible for Medicaid.
That’s why the decision to transfer the home 7 years ago was a smart move to maximize how much will be available for Mom’s care down the road. It’s just that the way they went about didn’t consider all the consequences, specifically taxes.