If you're at the stage of your life where you have spent decades working hard to build a solid financial future for your family, and are now in a position to make the lives of your adult children more financially comfortable, you may be wondering about the best way to go about that—for them and for you. Perhaps you're also wondering if a time is coming when you will need long-term care outside of your home. You don't want your assets to go to the nursing home; you want them to go to your family. Should you just go ahead and transfer assets to your children now? You could, but doing so is not without risk. Let's talk about some of the pitfalls of transferring assets to adult children.
You would do anything for your children, and you believe they would do the same for you. So it doesn't occur to you to hesitate to transfer assets, even the deed to your house, to them. You have an understanding, implicit or explicit, that if you have a need, they will take care of you or even transfer the asset back to you. You might even have a "wink and a nod" agreement with them: the asset is theirs in name only, but really, you both intend that it is yours.
The difficulty with this is that, when you transfer title to an asset, it legally belongs to the person to whom you transferred it. Your child might give the asset back to you if you ask for it, but they may not, and you have no legal grounds to compel them to. Arguing that the transfer was in name only might open the door to the question of why you made such a transfer, and whether you intended to defraud anyone by doing so (more on that below).
Once the asset belongs to your child, they can do what they wish with it: sell it, give it away, convert it into a different type of asset. Even if you know they wouldn't do such a thing, the asset is not safe. If your child ends up in debt, they could lose the asset, which is legally theirs, to their creditors. If they are married, but get divorced, the asset could be seen as marital property and awarded to their spouse. If your child predeceases you, the asset would likely end up in the hands of your child's widowed spouse, who may not be inclined to return it to you. The point is, once you transfer an asset outright to your child, you lose all control over what happens to it.
If you gift significant assets to your adult child, you, or they, could be faced with certain tax issues. If the amount of the gift exceeds $14,000 (for a single taxpayer) or $28,000 (for a married couple filing jointly) you will need to file a gift tax return, and the amount of the gift that exceeds the annual exemption amounts above may be subject to gift tax.
The bigger issue, however, is the possibility of your child someday having to pay capital gains tax. The amount of gain (or loss) on an item is the difference between its basis and the amount it is sold for. If the asset is sold for more than its basis, there is a gain. But what is the basis?
Usually, the basis is what you paid for the asset, say, a house. Let's say you give your house, for which you paid $100,000, to your child during your lifetime. Your basis in the house is $100,000. Your child also takes your $100,000 basis in the house. If she sells it for $300,000, she may pay tax on a gain of $200,000.
However, if your child inherits the house from you at your death, her basis in the property will be its value as of the date of your death. If the house is worth $300,000 at your death, and your child turns around and sells it for that price, she will not pay capital gains tax (which is currently around 20% for this type of asset). If you want to save your child a $40,000 tax bill, you may not want to transfer your home, or another large asset, to her during your lifetime.
Certain government benefits, such as Medicaid, require you to have assets below a certain amount in order to qualify. You may think that you would never need Medicaid; after all, you worked hard all your life, and saved a decent amount of money. But the reality is, if you need nursing home care for an extended period in the future, it is very likely that you will need Medicaid.
Nursing home care can cost upwards of $100,000 per year. Even the least expensive care available is still very costly. You might think that a good way to divest yourself of assets in order to qualify for Medicaid is to give those assets, now, to the people you intend to have them anyway—your children.
Unfortunately, Medicaid law is several steps ahead of you. Anticipating that people might attempt to reduce their assets by giving them away to family members, Medicaid imposes a five year "look-back" period. If an individual has transferred assets to anyone for less than the asset's fair market value during that period, their eligibility for Medicaid benefits could be delayed or even denied. This could put great pressure on your family, and they may end up needing to sell those assets after all to pay for your care.
How does the penalty for violating the look-back period work? The penalty period is determined based on the dollar amount of assets you transferred divided by either the average daily or monthly rate of nursing home care in your state. Let's say you transfer $100,000 in stocks to your adult child a year before you apply for Medicaid and the average monthly cost of nursing home care in your state is $5,000. You would be ineligible for Medicaid benefits for 20 months ($100,000 divided by $5,000).
There are ways to preserve your assets for your children without risking loss of the assets, or running afoul of Medicaid or tax laws. Speak with an estate planning attorney who is experienced in the areas of Medicaid planning and asset protection to ensure you're able to pass your wealth on to your children without causing trouble for them or yourself.
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