A common question for estate planning attorneys is “should I give my kids the house now or leave it to them in my estate plan?” This simple question requires some analysis before an answer is found. The formal terminology for the person making a gift is a donor, and the recipient is the donee.
Transferring real estate to your children [or any donee] while you’re alive may avoid the probate court process that otherwise follows death. Despite this advantage, however, the drawbacks abound. A transfer such as this is considered a “gift”. Gifting a house now, while you are living, can result in unnecessary taxes and put the property at risk. Has the gift tax been considered? What if an adult child is sued, filing for divorce or bankruptcy? And will this approach be effective for so-called nursing home protection? Don’t assume so.
MarketWatch’s recent article entitled Why you shouldn’t give your house to your adult children advises that there are better ways to transfer a house to your children, as well as a little-known potential fix that may help even if the giver has since passed away.
If you bequeath a house to your children so that they get it after your death, they get a ‘step-up in tax basis’. All the appreciation that occurred while the parent owned the house is never taxed. However, when a parent gives an adult child a house, it can be a tax nightmare for the recipient. For example, if the mother paid $100,000 for her home in 1986, and the current market value is $500,000, none of that gain would be taxable, if the son inherited the house.
Families who see this mistake in time can undo the damage, but they must seek an estate planning office like McManus Estate Planning, that has a focused law practice on this complex area. So the answer to the common question “should I give my kids the house now or leave it to them in my estate plan” will usually result in a recommendation to organize the estate with one or more Trusts.
Sometimes people give their house now to their children rather than in a formal estate plan in an attempt qualify for Medicaid, the government program that pays health care and nursing home bills for those that qualify. However, any gifts or transfers made within five years of applying for the program can result in a penalty period, when seniors are disqualified from receiving benefits.
In addition, should you give your kids the house now can expose you to their financial problems. Their creditors could file liens on your home and, depending on state law, get some or most of its value. In a divorce, the house could become an asset that must be sold and divided in a property settlement.
However, Tax Code says that if the parent retains a ‘life interest’ or ‘life estate’ in the property, which includes the right to continue living there, the home would remain in her estate rather than be considered a completed gift. In this instance, the client will not give the kids the house now. This is often referred to an an incomplete gift. Examples of incomplete gifts are life estates and certain forms of irrevocable trusts.
There are specific rules for what qualifies as a life interest, including the power to determine what happens to the property and liability for its bills. To make certain, a child, as executor of his mother’s estate, could file a gift tax return on her behalf to show that he was given a ‘remainder interest,’ or the right to inherit when his mother’s life interest expired at her death.
There are smarter ways to proceed rather than giving your kids the house now. There are other ways around probate. Many states and DC permit ‘transfer on death’ deeds that let people leave their homes to beneficiaries without having to go through probate. Another option is a Trust, and this should be closely examined before you decide on a particular transfer.
Reference: MarketWatch (April 16, 2020) Why you shouldn’t give your house to your adult children?