Who among us doesn’t love to receive gifts especially from a loved one? When we contemplating giving property of value that has appreciated since its purchase, the manner in which we gift could mean the difference between a large capital gains tax liability for the recipient or no tax at all. Simply put, the taxes due on the sale of an asset can be drastically different depending on how the asset is gifted.
Imagine parents decide to give their home to their son in order to protect this legacy from long-term care costs. Obviously, the child didn't pay for the home so it's considered a gift with parents obligated to file a gift tax although no gift tax will be due unless their estate is more than $10M+ . The more the property’s worth at the time of its sale by their son, the greater the gain and the larger the tax bill for him will be.
The reason for this tax treatment has to do with tax basis. Your tax basis in any asset you own is essentially the purchase price. In the case of a house, any cost of repairs or improvements can increase your basis. The exception is that assets ‘step-up in basis’ to their fair market value at the death of the owner. By gifting the home during their lifetime, these parents unwittingly handed their son a capital gains tax bill along with the gift. Son is probably not complaining about the tax but what if there is a better plan?
Had the parents have used a revocable trust to own the home or prepared a ‘transfer on death’ deed, son would inherit the residence with a full step up in basis at their death with the asset avoiding probate. However, the objective was to avoid having to ‘spend down’ the homes’ equity to pay for long-term care. Therefore, their best plan would be either an irrevocable trust (more on that in a later article) or ‘a lady bird’ deed. This deed accomplishes all of their goals: it provides a step-up in basis at death; protects the asset from long-term care spend-down if drafted before care is required (5 years before); and, best of all, it provides protections that the parents may will not have known they needed. The deed preserves their right to live in the house for the rest of their lives without paying rent or sell it if need be and by delaying son’s ownership, the house to step up in basis at their death but the house is protected from their son’s potential creditors, his divorce, even his decision to sell.
This is just one of the many ways our estate planning law firm helps families create a plan that works for their unique situation. Call us for a complimentary consultation or register for our complimentary seminars on this topic.
Reference: Fox 61 News (January 4, 2016) "Tips to avoid an income tax and estate planning time bomb"