Should I Deed My House to My Kids?
By Randall M. Jacobs, J.D.
Board Certified Indiana Trust & Estate Lawyer by the Trust & Estate Board of the Indiana State Bar Association
Many people have questions about the legal effects of transferring their residential real estate to an adult child. There can be some benefits to doing this, but it is important to understand the potential disadvantages before you proceed.
There are basically three ways of "putting a child’s name" on real estate: 1) an outright gift; 2) a deed reserving a life estate; 3) a "transfer on death" deed.
Outright Gift. An outright gift is irrevocable. If a parent transfers real estate outright, the parent loses control over the property and would not have the legal right to live there. The parent is essentially going on faith that the child will allow the parent to keep living in the home. The parent generally should pay rent, and if the parent is continuing to pay taxes and insurance, this should be addressed in a rental agreement. Once a parent transfers real estate to a child, it becomes impossible to remove that child's name without the child's consent. By contrast, if a parent's Last Will and Testament leaves real estate to a child but the parent later decides to give it to someone else, the parent can simply execute a new Will.
An outright gift generally ends the parent’s right to claim any property tax exemptions, such as the homestead exemption, the mortgage exemption, or exemptions for being blind or over 65. This can dramatically increase property taxes.
Generally if you sell your own home, you do not have to pay capital gain taxes on any profit up to $250,000. If real estate transferred to a child is worth more than what was paid to purchase and improve it (the property's "cost basis"), then the child would pay income tax on this "capital gain" on the sale of the property. To remain eligible for the exclusion of gain for a residence you have to both own and live in the property.
Additionally, a complete transfer of property to a child may cause problems for the parent if the child goes through a divorce or has debts they cannot pay. Since a transfer of the real estate create an ownership in the children, the children's spouse and creditors may have the ability to seize the property.
If the motivation for transferring the real estate to children is to remove it as an asset that would be considered for Medicaid qualification, remember that a transfer of your real estate can make the parent ineligible for public benefits such as Medicaid for nursing home expenses, depending on when you enter the nursing home. The length of time the parent would be ineligible depends upon the value of the real estate, and whether it was transferred outright or subject to a retained a life estate. Generally, a complete transfer of real estate will affect Medicaid eligibility for five years from the date of transfer; in other words, the entire value of the home is considered an available asset for five years after the date of transfer.
A transfer of real estate is a "gift" for gift tax purposes, and will require the filing of Federal Tax Form 709 to report the gift to the IRS and the payment of any gift tax generated by the transfer.
Gift with Retained Life Estate. A second way to transfer property is for the parent to deed it to children, but retain the right to live there for the parent's lifetime. This is called reserving a "life estate." During life, the parent has the right to live in the property, and at death the life estate ends, and the "remaindermen" immediately own the property. Some people transfer real estate but retain a life estate to expedite the (non-probate) transfer of the real estate after death, and possibly to avoid any court administration of their estate after death. However, this might have unintended consequences should a remaindermen child die first. For example, a parent's Last Will and Testament may provide that an inheritance would go to grandchildren if a child died before the parent. But if the parent had transferred real estate to this child and reserved a life estate, and if the child was married at the time of the child's death, then the child's share in the real estate could pass to the deceased child's spouse, rather than to the grandchildren.
If the parent transfers real estate but retains a life estate, the parent continues to have the legal right to live there (or receive rent payments from the land if somebody else lives there) that cannot be disturbed by a child, or the child's creditors. However, the parent still loses a significant degree of control over the property. For example, if the parent sells the property, the proceeds would belong to the parent and the remaindermen, and would be split according to the percentage of ownership at the time (determined by IRS life-expectancy tables). Capital gain tax would be owed by the child on his or her gains.
If the parent retains a life estate and the property is not sold before the parent dies, then under current law there would be no capital gain at the time of death because its cost basis is "stepped up" to the property's market value on the date of death.
For Medicaid calculation purposes, the parent is deemed to own the entire interest in the real estate for five years after a deed retaining a life estate, and will be the owner of the life estate interest thereafter. The value of the life estate interest would be calculated at the time of application for Medicaid, and would be counted as an available asset.
Transfer of Death Deed. Indiana recently created a new deed form, called a "transfer on death" deed. As the name implies, this is a deed that does nothing more than transfer real estate to the person named in the deed at the owner's death. During the owner's lifetime, the TOD beneficiary has no rights or interest in the property. The parent is considered the owner for all purposes until death. This type of deed can streamline the process of getting real estate to a child at death, although it can become problematic if there are multiple children.
From an inheritance tax perspective, the entire date-of-death value is taxable to the child, and the child gets a complete step-up in cost basis. From a Medicaid planning standpoint, the entire house belongs to the parent, and is considered an available asset, unless one spouse is not in the nursing home.
Whether and how to transfer an interest in residential real estate is very fact-specific. There is no "one size fits all answer," and you need to take all factors into account, and talk with an attorney knowledgeable about all aspects of estate planning, before making such a big decision.
Disclaimer: These materials are for informational purposes only and should not be construed as legal advice on any specific facts or circumstances. We recommend you consult a lawyer if you want professional assurance that your interpretation of these materials is appropriate to your particular situation.
© Yoder Ainlay Ulmer & Buckingham, LLP [June 2011]