|Determining the best way to transfer the ownership of a home from parent is very important part of estate planning and asset protection.
There are 3 ways to transfer the ownership of a home from parent to child:
- Outright gift
- Gift with a reserved life estate
- Gifting by trust
The problem with an outright gift is that the child would lose what’s called the step-up in basis, therefore have the worst income tax result for the property. Without the step up in basis, when the child will eventually sell the property, he or she will pay capital gains tax on the difference between the sale price and the cost of the purchase. With the step up in basis, this cost is readjusted to the fair market value of the property at the time when the parent passes away, and capital gain tax reduced significantly or completely eliminated.
Additionally, the child would lose the exclusion from income tax of $250,000 for a single person and $500,000 for a couple.
A life estate means that the house is deeded to the children, but the parent reserves the right to live in the house for the remainder of their life. This makes it possible to avoid the capital gains tax. When the parent dies, the children will get a step-up in basis.
The disadvantage of a life estate is that if the house is sold during the parent’s lifetime and the parent is on Medicaid, Medicaid might claim some portion of the sale to cover the benefits received by the parents.
The advantage of a trust is that by transferring the house from the parent to their child as trustee, it’s possible to get the step-up in basis. The trust also protects the house from Medicaid lien. If you are choosing to gift via a trust for Medicaid purposes, there are legal mechanisms in which the parent is still involved in the administration of the trust. The parent can decide to change the trustee at a future point, and it is also possible to change beneficiaries of the trust.