Should I transfer my home to my kids?

Concerned seniors often ask me whether they should start moving their assets into their children’s names as they advance in age.  Things like their home, land, stocks, and savings can be at risk if an extended stay in a nursing home developed.  With the recent changes to the Medicaid “look-back” due to the recently signed Deficit Reduction Act of 2005 (DRA) the question becomes harder to answer than ever before. This is because “last minute” options for protecting assets have become very limited. 

One of the most important disadvantages in transferring what’s in your nest egg before you die deals with taxes.   Here’s why….

If you hear someone say to you that you may have lost your “Step Up” you don’t need to call a physical therapist in fact you should see an accountant.   What this phrase refers to is the ability of your heirs to save capital gains taxes on an asset of yours, such as your house, when you die.

Let’s take a look at an example.  But first we need to understand what is meant by the accounting phrase “cost basis”.  “Cost basis” in its simplest form is what we originally paid for something.  There may be other things to factor in such as depreciation, improvements, and even taxable additions among others. 

Let’s say your home was purchased for $15,000.  That’s your “cost basis”.  Now many, many years and a real estate boom later it’s worth $150,000.  That works out to a $135,000 gain.  Your friend tells you to transfer your home into your children’s names so you don’t lose your house someday if you get sick and have to go into a nursing home. You take your friends advice and transfer your home into your kid’s names.  Eventually you pass away and guess what happens when they sell the house?  That’s right, the IRS informs your heirs that capital gains taxes are due on the proceeds of the sale.  Based on the rate that most of us pay, 15%, that would be approximately $20,000 in taxes. 

Now most of you are saying by now that “I thought I could sell my home without any taxes?”.   Well, this is usually the case, however it’s not your name on the deed, it’s your kid’s, because you transferred it to them.  The home sale tax exclusion requires that YOU have owned and used the home as YOUR primary residence for periods totaling at least two years while maintaining ownership for five years ending on the date of the sale. 

So where does this “Step Up” come in?  Heirs receive a “Step Up” in basis on an asset to its fair market value on the day of the original owners death.  Taking from the above example, if the parent instead maintained ownership of the home until death rather than transferring it to the kids while they where alive the kids would be better off from a tax standpoint.  Why?  Because if the home was left to them after the parent died the kids would receive a “Step Up” in value on the home.  This would then create a new cost basis of $135,000.  If they where to sell immediately and received $135,0000 they would have no gain to report.  This would result in savings of approximately $20,0000 in taxes.

Tax-law is subject to frequent change, therefore it is important to coordinate with your tax advisor for the latest information on your specific situation prior to undertaking any strategy.

It can seem to be a bit of a “catch-22”.  If you transfer the home far in advance of a long-term care situation you may protect the home.  If you wait and pass it along when you die you may save taxes. You can’t do both.   It’s your choice to make.

 Jon Flynn is a Certified Financial Planner ^TM and owner of Flynn Financial in Eynon. He is a Representative of Securities America, Inc., Member FINRA/SIPC and of Securities America Advisors, Inc. Flynn Financial and Securities America are unaffiliated.   Mr. Flynn can be reached at 570-876-5015.