The challenges begin when homeowners don’t do any Medicaid planning and decide the best answer is simply to gift their home to their children. It doesn’t always work out well for the homeowners or their children, warns the article “Owning real estate without jeopardizing Medicaid paying for nursing home” from a midwestern website, limaohio.com.
A key tax avoidance opportunity is usually missed, when real property is gifted outright (among other problems). The IRS says that if someone owns real estate, when that person passes, the heirs may eliminate a large portion of the taxable gains, if the real estate ends up being sold by an heir for more than the original owner paid for the property.
Let’s walk through an example of how this works. Let’s say Verner buys a farm for $1,000. The cost to buy the farm is referred to as her “tax basis.”
If the family is planning for the possibility of nursing home costs, Verner might want to give that farm away to her children Page and Charlie. She needs to do it at least five years before she thinks she’ll need Medicaid to pay for long-term nursing care, because of a five-year lookback. (Long term care insurance might protect Verner during the 5-year lookback.)
When Verner gifts the farm to Page and Charlie, the two children acquire Verner’s tax basis of $100,000. Page gets $50,000 of the tax basic credit, and so does Charlie.
The years go by and Page wants to buy out Charlie’s half of the farm. The farm is now worth $500,000. So, Page pays Charlie $250,000 for Charlie’s half of the farm. Charlie now has a tax basis of $50,000 which is not subject to tax. And Page receives $200,000 more than her $50,000 tax basis, and Page will need to pay capital gains on that $200,000 gain.
It could be handled smarter from a tax perspective. If Verner owns the farm when she dies, then Page and Charlie get the farm through her will, trust or whatever estate planning method is used. If the farm is worth $300,000 when Verner dies, then Page and Charlie will get a higher tax basis: $300,000 in total, or $150,000 each. By owning the farm when Verner dies, she gives them the opportunity to have their tax basis (and amount that won’t be taxed if they sell to each other or to anyone else) adjusted to the value of the property when Verner dies. In most cases, the value of real estate property is higher at the time of death than when it was purchased initially.
There’s another way to transfer ownership of the farm that works even better for everyone concerned. In this method, Verner continues to own the farm, helping Charlie and Page both avoid taxes, and keeps the property out of her countable assets for Medicaid. The solution is for Verner to keep a specific type of life estate in the farm. This needs to be prepared by an experienced estate planning attorney, so that Verner won’t have to sell the farm if she eventually needs to apply for Medicaid for long term care.
Your estate planning attorney will be able to help you and your family navigate protecting your home and other assets, while benefiting from smart tax strategies
Reference: limaohio.com (Nov. 7, 2020) “Owning real estate without jeopardizing Medicaid paying for nursing home”