Whether it’s to qualify for Medicaid, avoid probate, or reduce your tax burden, transferring ownership of your home to your adult child during your lifetime may seem like a smart move. But in nearly all cases, it’s actually a huge mistake, which can lead to dire consequences for everyone involved. With this in mind, before you sign over the title to your family’s beloved homestead, consider the following potential risks.
1. Your Eligibility For Medicaid Could Be Jeopardized
With the cost of long-term care skyrocketing, you may be worried about your (or your senior parents’) ability to pay for lengthy stays in an assisted-living facility or a nursing home. Such care can be extremely expensive, with the potential to overwhelm even those families with substantial wealth.
Since neither traditional health insurance nor Medicare will pay for long-term care, you may look to Medicaid to help cover the costs of long-term care. To become eligible for Medicaid, however, you must first exhaust nearly every penny of your savings.
In light of this requirement, you may have heard that if you transfer your house to your adult children, you can avoid selling the home if you need to qualify for Medicaid. You may think transferring ownership of the house will help your eligibility for benefits, and this strategy may seem easier and less expensive than passing on your home (and other assets) through estate planning.
However, this tactic is a big mistake on several levels. It can not only delay—or even disqualify—your Medicaid eligibility, it can also lead to other serious problems. Here’s why: In February 2006, Congress passed the Deficit Reduction Act, which included a number of provisions aimed at reducing Medicaid abuse. One of these provisions was a five-year “look-back” period for eligibility. This means that before you can qualify for Medicaid, your finances will be reviewed for any “uncompensated transfers” of your assets within the five years preceding your application. If such transfers are discovered, they can result in a penalty period that will delay your eligibility. Any transfers made beyond that five-year window will not be penalized.
The length of the penalty period is calculated by dividing the amount of the uncompensated transfer by the average cost of one month of private nursing home care in the state you live in. These days, the average cost of nursing home care is roughly $10,000 a month. Given these figures, this means that for every $10,000 worth of uncompensated transfers made within the five-year window, your Medicaid benefits will be delayed for one month. So if you transferred the title to a home worth $500,000 within the look-back period, your Medicaid benefits would be delayed for 50 months.
In light of this, if you transfer your house to your children and then need long-term care within five years, it could significantly delay your qualification for Medicaid benefits—and possibly even prevent you from ever qualifying. Rather than taking such a risk, you may want to look into safer and more efficient options to help cover the rising cost of long-term care, such as purchasing long-term care insurance.
2. Your Child Could Be Stuck With A Massive Tax Bill
Another drawback to transferring ownership of your home in this way is the potential tax liability for your child. If you’re elderly, you’ve probably owned your house for a long time, and its value has dramatically increased, leading you to believe that by transferring your home to your child, he or she can make a windfall by selling it. And by transferring the property before you die, you may think that you can save your child both time and money by avoiding the need for probate. Probate is the court process used to distribute your assets according to the wishes outlined in your will or according to our state’s intestate succession laws if you don’t have a will. Depending on the complexity of your estate, probate can be a long and expensive process for your loved ones; however, that expense is likely to be relatively minor compared to the tax bill your heirs could face.
That’s because if you transfer your home to your child during your lifetime, he or she will have to pay capital gains tax on the difference between your home’s value when you purchased it and the home’s selling price at the time it’s sold by your child. Depending on your home’s value, that tax bill can be astronomical.
In contrast, by transferring your home at the time of your death via your estate plan, your child will receive what’s known as a “step-up in basis.” This tax savings is one of the only benefits of death, and it allows your child to pay capital gains taxes when he or she sells your home, based only on the difference between the value of the home at the time of inheritance and its sales price, rather than paying taxes based on the home’s value at the time you bought it. For example, say you originally purchased your home for $80,000, and when you die, the home had appreciated in value to $250,000. Your daughter inherits the home upon your death, and then she sells it five years later for $300,000. With the step-up in basis in effect, she would only owe capital gains taxes on the $50,000 difference between the home’s value when it was inherited and when it was sold.
However, if you transferred ownership of the home to her while you were still living, your daughter would lose the step-up in basis and would face a capital gains tax bill based on $220,000.
There are much better ways to avoid probate using estate planning, such as by putting your home into a revocable living trust, in which case your home would immediately pass to your loved ones upon your death, without the need for any court intervention.
3. Your Home Could Be Vulnerable To Debt, Divorce, Disability, & Death
There are a number of other reasons why transferring ownership of your house to your child is a bad idea. If your child takes ownership of your home and has significant debt, for example, his or her creditors can make claims against the property to recoup what they’re owed, potentially forcing your child to sell the home to pay those debts.
Divorce is another potentially thorny issue. If your child goes through a divorce while the house is in his or her name, depending on the outcome of the divorce, the settlement decree may force your child to sell the home or pay his or her ex-spouse a share of the home's value.
The disability or death of your child can also lead to trouble. If your child becomes disabled and seeks Medicaid or other government benefits, having the home in his or her name could compromise their eligibility, just like it would your own. And if your child dies before you and owns the house, the property could be considered part of your child’s estate and end up being passed on to your child’s heirs, leaving you homeless.
There’s Simply No Substitute For Proper Estate Planning
Given these potential risks, transferring ownership of your home to your adult child is almost never a good idea.
We offer a variety of different estate planning packages at a variety of different price points as part of our Life & Legacy Planning Process. With our guidance and support, we will not only help you protect and pass on your home, but also all of your family’s wealth and assets.
This article is a service of the Law Office of Keoni Souza, LLC, an estate planning law firm in Honolulu, Hawaii. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That is why we offer a strategic planning session, during which you will get more financially organized than you have ever been before and make all the best choices for the people you love. You can begin by contacting our office today to schedule a planning session and mention this article to find out how to get this $750 session at no charge. Disclaimer: All information on this website is for informational purposes only and is not legal advice. You should contact an attorney trained to work with families on estate planning matters regarding your specific situation. Use of and access to this website or any of the email links contained within the site do not create an attorney-client relationship between the Law Office of Keoni Souza, LLC, and any users or any other party.