Last week I addressed the legal issues raised by “R.B”, who said that his mother was asking if she should transfer title to her house into the name of R.B. (her son) and his wife. He liked the idea of avoiding probate, but wanted to know if there were any negatives to owning his mother’s house while she was still living.
There are a wide variety of negatives. They include: a) possible violation of the terms of her mortgage, b) possible federal gift tax complications, c) possible increases in capital gain taxes, d) the great likelihood of a large increase in local property taxes, d) mom’s possible disqualification from receiving Medicaid benefits, and e) ownership complications between R.B. and his wife as gift recipients.
Due to those complicating factors, receiving a house via gift deed may be the wrong approach. But there is a different legal strategy available to R.B. and his mother which eliminates the complications. A specialized life estate deed arrangement can be designed and written by your certified elder law attorney which can address the negatives and turn them to your advantage.
Mother will sign a deed conveying the property to R.B. and his wife, while retaining life estate for herself. Then, so long as mother is still alive, the house is still legally treated as her homestead. However, at the moment of mother’s death her interest expires and R.B and his wife become full owners of the property. The transfer happens without the need for probate. It is important to include special terms in the deed that allow mother to change her mind at any time she desires. Even if she does not use the power to reverse the transaction, the mere power has positive legal consequences.
The complications of an outright gift are eliminated using this special type of reserved life estate. First, the terms of the mortgage will not be violated as there is no ownership change during mother’s lifetime. The security interest she has granted to the mortgage company is not violated. At the moment of her death, the property is transferred, but that would also happen through some legal process like probate of her Will, and does not violate the mortgage.
Second, there is no gift tax consequence. Since mother has retained authority to withdraw R.B.’s remainder interest so long as she lives, there is no value to R.B.’s interest until mother’s right to withdraw has expired at the moment of her death. Thus, there is no lifetime gift that would be subject to the gift tax.
Third, since R.B. and his wife do not actually own the house until the moment of mother’s death, they are awarded a free step-up in basis under the tax code. This eliminates the chance that they will be exposed to higher capital gain taxes due to receiving the house as a gift, if they decide to sell the house instead of living there.
Fourth, the local tax assessor must legally continue to treat the property as mother’s homestead, and must continue to grant to mother her 65+ exemption, her homestead exemption and her school tax freeze. Mother still owns the property until the moment of her death. After that, yes, the property taxes will increase; but they will stay at the lower rate until mother dies instead of jumping up right away.
Fifth, since mother has retained the power to reverse the transaction, in the eyes of Medicaid there has been no gift and no disqualification from benefits results. The key to this outcome is that no value is transferred until the moment of mother’s death. The house remains her homestead and is an exempt asset under the Medicaid rules. The bonus is that this type of deed currently protects the homestead against claims under the Medicaid Estate Recovery Program.
Finally, if R.B. and his wife receive the house as a gift, they each receive a one-half interest as their separate property. This is the only challenge that is not cured by using a reversible life estate. Instead, after mother dies, R.B and his wife need to sign a document that converts their separate property interests into community property. Once done, they will gain a future step-up in basis tax benefit (to be used when one of them dies) that they would lack if it remained separate property.
Paul Premack is a Certified Elder Law Attorney practicing estate planning and probate law in San Antonio.
Original Publication: San Antonio Express News, February 13, 2012