Thinking of transferring your home to your children? Is this a smart move that can help provide for them and minimize tax liability?
Why are You Transferring Your Home?
The desire to transfer your home to your children to ensure that they are provided for later, or so that the home remains in the family, is completely understandable. Unfortunately, there are many misconceptions that lead parents to make the wrong moves, which may have disastrous consequences for all involved later on. For those asking the question, “How can I transfer my house to my child?” in order to escape legal action and losing their homes or equity, the bottom line is that this is a futile route, akin to jumping out of a plane without a parachute. Any transfers done specifically to hide assets from creditors or a vindictive ex often offer no protection in court.
Sadly, most homeowners wait too long to begin estate planning and rush into the wrong decisions. So what are your options for transferring real estate to your kids and what do you need to watch out for?
How Can I Transfer My House to My Child?
1. Sell Your Home & Gift the Cash
If you are simply worried about providing for your children financially after you are gone, you could simply sell your home and gift them the proceeds. This will enable you to take advantage of tax exclusions for capital gains. This currently applies to the first $250,000 on the sale of your primary residence or $500,000 for married couples – provided you owned and lived in the house two out of the last five years. This may be fine if you don’t want to live in the home anymore, though it can affect your eligibility for receiving government assistance.
According to Grant M. Yochim, an attorney with the Steadman Law Office in Pennsylvania, overlooking the need to fund long-term care, including nursing home care, and the effect that a large transfer of assets to family can have on your eligibility for Medicaid benefits are among the biggest mistakes people make today. Here’s why:
The cost of long-term custodial care – everything from adult day care centers to skilled nursing facilities – can be crippling. A semi-private room in a nursing home now runs over $200 per day, according to the 2012 Genworth Cost of Care study. And assisted living facilities average more than $3,000 per month. That’s enough to overwhelm a retirement pension, and leave nothing for a spouse to live on. What’s more, Medicare has limits as to how much of these costs are covered.
Further, state governments impose strict eligibility requirements on your ability to qualify for Medicaid. Specifics vary by state, but generally, you must have a poverty-level income or less, and have less than $1,700 to $2,000 in total assets, before you can qualify for Medicaid.
It won’t do to transfer your home to meet the asset requirements. Under the terms of the Deficit Reduction Act of 2006, Medicaid officials can look back up to five years and disallow gifts and other asset transfers for the purposes of determining Medicaid eligibility.
Meanwhile, though, states generally exempt some amount of home equity from the eligibility requirement along with a few other basic assets, like a funeral plot, a burial plan, a limited amount of assets for the “community spouse,” or a spouse not requiring long-term care to live on.
By transferring your home, you may be transferring an asset that may be exempt anyway. And if you do it within five years of needing benefits, you may disqualify yourself from receiving Medicaid benefits.
One possible solution: If your state has a “long-term care partnership program,” you could buy a qualifying long-term care policy. These long-term care partnerships allow you to qualify for benefits under Medicaid once your long-term care insurance policy benefits are exhausted, while allowing you to keep assets equal in value to the total benefits paid under your LTC policy. For example, if you have a $400,000 home, you can buy a long-term care policy that provides up to $100,000 in benefits per year for four years. This policy will allow your family to keep the home, if your state has a long-term care partnership program.
2. Gifting Real Estate to Your Children
Clearly selling your home outright to your children can be incredibly expensive and result in many fees and taxes. However, trying to gift your house to your kids by adding them to the title can present a number of challenges too. For a start, any transfer of ownership technically means that transfer taxes are due, even if no cash is changing hands. Gifting the home to your children may trigger the gift tax. Many homeowners mistakenly believe that adding their children on title as joint tenants can help avoid taxes.
However, depending on where you live, there can still be inheritance tax due on the percentage of the property being transferred to your children after you pass on. If you have a mortgage on the property, gifting your home will also technically trigger the “due on sale” clause, bringing your entire loan balance due immediately. Check if your home loan is assumable so that you can avoid this.
3. Let Your Child Inherit the Home
Attorneys and financial planners often do a great job of scaring individuals about the faults in the system that can sometimes wind up in probate issues and result in your estate not being distributed the way you hope. However, it is true that with a solid will and some expert estate planning help one of the best options from a tax perspective is just to allow your child to inherit the property after you die. Some states have a minimal inheritance tax rate for property passed to children, like PA’s 4.5 percent. In other states no estate tax is due unless the inheritance is valued well in the millions of dollars range.
If you go this route, be aware of federal estate tax rules. Generally, your estate will be assessed a tax of 35 percent of everything over 5 million dollars. If one or both spouses are foreign nationals, a lower exemption will apply. If you are married, the surviving spouse receives an unlimited marital exemption; the estate will be taxed upon the death of the second spouse. This could require some planning to ensure that there is enough cash liquidity in the estate to pay the estate tax to avoid having to sell the home to raise the cash. Life insurance is one cost-effective traditional solution to this problem, though there are other options as well, such as the use of trusts. Note that only irrevocable trusts allow those assets to avoid the estate tax. But you also give up control with an irrevocable trust, so there are downsides (see below for more on the use of trusts).
What Dangers do I Face if Transferring My House to My Child Now?
In an interview with William J. Purdy, III of the Law Offices of Simmons & Purdy in California, Bill said “Transferring one’s home to one’s children has to rank right up there with some of the worst ideas ever conceived by modern homo sapiens since the dawn of our species.” Bill conducts a variety of tax and property classes for the firm and a Lincoln Law School. In his 20 years of experience, he says he has seen many horrendous outcomes stemming from parents transferring real estate to their children. He specifically points out issues that can jeopardize the property as well as some outlandish actions by mischievous children.
For a start, once transferred or added to the property, any actions by the children can put the asset at risk. Debts they take on, divorces and auto accidents can all result in judgements against the home. In some cases children encumber the property with mortgages, strip the equity and let it go into default. To their horror the children they transferred to have even evicted some parents from their own homes!
How Can I Safely Transfer My House to My Child?
Still asking, “How can I transfer my house to my child?” Bill Purdy suggests, “Run … don’t walk from any financial planner or attorney who suggest this.” And to “Please, please use a revocable estate planning trust to get the home to the children after both parents are deceased.” A revocable trust will at least allow you to take back control of your home and guarantee a roof over your head in case your cute kid turns into a wild child.
It is never too early to begin estate planning. In fact, having a plan before you even purchase a home in the first place is wise. However, no matter where you are at now, just make sure you interview several real estate and tax professionals before making a decision. Sleeping in tents may seem like a cool idea for a family vacation, or even a protest, but perhaps not so fun if it is because your heirs blew their inheritance early or kicked you out in the street.