Question: My aunt has a home that she purchased in 1980. It is now worth $300,000.00 and she wants give it to me to protect it from the cost of nursing home care. Can she just deed it to me? My lawyer is suggesting a trust. What is the difference?
Answer: This is a good question. If you aunt wants to protect her house, why not just transfer it to you? The problem is that there may be adverse tax consequences if the real property is transferred to you outright. First, you would take the property at your aunt’s cost basis. Given that she purchased it in 1980, her basis is probably quite low. That means that you would owe capital gains when you eventually sold the property. In addition, she would no longer be entitled to her capital gains exemption if she sold the property before her death. Presently, the capital gains exemption is $250,000.
Here is a simple example: Suppose she purchased the house for $25,000. She has put $50,000 in improvements on the property. Her basis for capital gains purposes is $75,000. If she sold the property during her lifetime, her capital gain would be $225,000. With her $250,000 exemption ($250,000) she would pay no capital gains tax when sold. However, if your aunt deeded the property to you during her lifetime, that exemption would be lost for most of the sale. She could only use the exemption for the life estate value of the property. For instance, the life estate of an 86 year person may be deemed to only 1/4 of the value of the property. She could use her exemption for this amount, but the other $200,000 would be paid to you and taxable as a capital gain. Assuming you did not reside in the property for two years or more, you would not be able to use the $250,000 exemption. You would owe capital gains tax when you sold the property, a potential tax of 20% or more on the gain. Your aunt would lose the Star exemption and the Veteran’s exemption, if she previously has those exemptions. This might be costly.
You could solve part of this problem by having your aunt transfer the property to you but retain the right to reside there for the rest of her life. However, this only partially solves the problem. When she dies, the property would be solely yours and there would be a “step-up” in basis. If you sold the property at the date of death value, you would have no capital gains tax. In addition, your aunt could continue to receive the Star exemption and the Veteran’s exemption. This would be better than an outright transfer of the property to you. However, if for some reason you needed to sell the property during your aunt’s lifetime there could again be adverse tax implications.
Nevertheless, the Irrevocable Trust would be the best solution. If your aunt transferred the property to an irrevocable trust, she could still maintain her Star and Veteran’s exemptions on the property. If the house was sold, she could use the $250,000 exemption for the entire purchase price, thus negating any capital gains tax. Also, if she died and you inherited the property, you would get a full step up in basis at the time of her death. Also, you aunt could designate who gets the property if you should predecease her. She might like the flexibility of this plan. Contrary to what many people believe, even with an irrevocable trust, changes can be made. This is the planning option which affords maximum flexibility and the best protection of the asset taking into consideration all of the potential tax implications.