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Your Estate – Your Children – The Skinny

It is not uncommon for aging homeowners to transfer ownership title of their home or property to a younger family member - be it a son, daugter, or grandchild - before they pass on.  Besides the act being an obvious gesture of a gift, there is also the benefit of protecting the estate from Medicaid claims for end-of-life medical expenses or nursing home costs.   

However, many estate planners are warning that simply deeding a home to your child may cause by anguish then relief.  First of, you (the parent) will lose control over the property, and secondly, your child or grandchild, may grow resentful of the potential costly nature of the "gift".  They could wind up paying considerable capital gains taxes if they decide to sell the home.  Also, protecting the estate from Medicaid may prove to be fairly limited.   

Under the currently laws, people with insufficient funds may be eligible to have their long-term nursing home care covered by Medicaid.  However, if the individual owns a home, then Medicaid can place a legal claim (liens) on it to recover some of the benefits paid.  This is the reason why many aging homeowners attempt to shield their property from Medicaid liens by transferring ownership in the form of a gift, to their children or other loved ones.  But many of these people do not know, and find out too late, that such transfers are subject to a three-year "look-back period."

So upon transferring your deed over, the three-year Medicaid clock begins to tick.  So this means that if the transfer takes place less than three years before Medicaid benefits are sought, there is a waiting period before benefits can begin. The waiting period is calculated using a formula that takes into consideration how much the asset was worth and how recently the transfer was made.

Simply deeding the property can have some other drawbacks.  The most prominent disadvantage is the loss of legal control of the state.  Cormac McEnery, an estate-planning lawyer in City Island in the Bronx, said that he has seen his fair share of complications arising from a transfer of deed outright, or in "fee simple", from parent to child.  In most of these cases, the child will have a falling out with the parent(s).  The parent will often find out that they have no legal power to redistribute ownership among the estate, unless the child willingly consents too.

Another big drawback of transferring deeds is the significant tax implications for the child or loved one receiving the estate.  A standard "fee simple" conveyance of the property as a gift, for example a parent transferring house deeds to their child as a gift,  will mean that the child will automatically assume the parent's tax basis.  This tax basis is used to determine the taxable capital gain for when the home is sold.

So, if the parent bought the home for $100,000 in 1975 and the child ultimately sold the house for $500,000 without owning and using it as a primary residence for two years and thus getting a tax break, the taxable gain would be $400,000 (less any improvements).  At the current federal capital gains tax rate of 15-percent, the child would have to pay $60,000 in federal taxes on a $400,000 gain and would probably be responsible for state capital gains taxes as well.  This turns out to be more  of a burden rather than a gift! 

However for homeowners, an optimal transfer of estate can be accomplished by including a "special power of appointment" clause in the deed.  This clause (1)ensures that the homeowner not only retains control over who will ultimately own the home; (2) protects the home from potential Medicaid liens; (3) starts the three-year Medicaid look-back clock ticking; and (4) eliminates the capital gains tax problem for the children.

With a special power of appointment clause, a homeowner retains the rights to transfers title of the home to whomever he want, either during his lifetime or through his will.  For Medicaid purposes, such a transfer is considered a completed transfer.  But for tax purposes, the transfer is considered an incomplete transfer since the parent reserves the right to change his mind and retitle the property to someone else.  The transfer only becomes completed upon the death of the parent.  And when that occurs, the children benefit from a stepped-up tax basis - equal to the market value of the property at the time of the parent's death, rather than the original acquisition cost.

The "Special Power of Appointment" Clause will have strong implications not only for Medicaid and federal and state tax purposes, but for title insurance purposes as well.  It is an important strategy that most families can utilize, but the best advice is to consult an experienced elder-care lawyer.  The reason being is that the transfer of the deed can be a relatively technical procedure.  The language used in the Special Power of Appointment clause must be precise to ensure that all benefits will be properly met.