Many people work hard to acquire real estate and then later find that that real estate makes them ineligible for Medicaid to help pay for nursing home or in-home, long-term care. To get around this struggle, people sometimes make gifts of all of their real estate to their kids.
Perhaps the biggest potential downside to simply giving real estate to heirs early is that a key tax avoidance tool can sometimes be missed.
The Internal Revenue Code states that if someone owns real estate when that person dies, the heirs (who receive that real estate after the person’s death) may be able to eliminate a large portion of the gains (that are taxed) if the real estate is later sold by an heir for more than the original owner paid for the real estate.
To understand this principle, presume that Abby buys a farm for $1,000, which cost to acquire is called a “tax basis.”
To plan for possible, eventual nursing home need, Abby could give that farm to her children, Bob and Chad, at least five years before Abby thinks she might need care. When Abby gives the farm to Bob and Chad, Bob and Chad acquire Abby’s tax basis of $1,000, with Bob receiving $500 of tax basis credit and Chad receiving $500 of tax basis credit.
Later, Bob decides to buy out Chad’s half of the farm. At that time, the farm is worth $5,000. Bob pays $2,500 to Chad for Chad’s half of the farm. Chad has a tax basis of $500, which is not subject to tax. However, Chad receives $2,000 more than his $500 tax basis, and Chad will have to pay capital gains tax on that $2,000 gain.
However, instead, if Abby owns the farm when Abby dies, Bob and Chad can get the farm through Abby’s will, trust or other method. If the farm is worth $3,000 when Abby dies, Bob and Chad each get a higher tax basis: $3,000 in total or $1,500 each for Bob and Chad. By owning the farm when Abby dies, Abby gives Bob and Chad the chance to have their tax basis (and amount that will not be taxed if they sell to each other or anyone else) adjusted to the value when Abby dies, which is usually higher than Abby’s purchase price.
How can Abby both own the farm (to hopefully, eventually help Bob and Chad avoid taxes) but also not have the farm be “countable” for Medicaid? The answer is often for Abby to keep a certain type of life estate in the farm, which life estate has to be prepared with precision to avoid Abby having to sell the farm if Abby eventually needs long-term care.
The biggest struggle with this certain life estate planning strategy is that Medicaid can assert a lien on the farm after Abby dies anyway. This lien is a percentage of farm value based upon Abby’s age when Abby dies, which is usually much smaller than the whole value of the farm.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at [email protected] or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.