Very often, a person’s home is one of the single largest assets they may own. As a means of attempting to protect the home from long-term care expenses, an individual frequently wishes to transfer the house to one or more of the children, which, on its face, appears to be a relatively simple and straightforward transfer or conveyance.
However, there are many issues that must be discussed and resolved prior to the transfer so as to maximize the intent of the transferor as well as to maintain all income tax, estate tax, and gift tax benefits, to the extent possible.
The life interest is merely a form of ownership whereby the person transferring the property, usually the parent, retains the right to use, occupy, enjoy, and live in the residence. The transfer usually occurs with the transfer to the children, who receive what is commonly known as a future interest in the property.
This special form of ‘dual’ ownership is not a joint ownership, nor have the parents made a completed gift of the entire real estate to the children. However, the parents are not able to sell, mortgage, refinance, or in any way encumber the property without the consent of the children. Likewise, the children may not transfer or sell the property without the signatures of the parents.
The procedure to complete this transaction involves a deed from the grantor to the grantee, which must be recorded with the appropriate Registry of Deeds. Once the recording of the deed is effective, the children own an interest in the property as well as the parents.
The additional benefits to this type of transaction are threefold. The first is that the property will avoid having to be probated upon the death of the parent. Keeping in mind that each party owns an interest in the real estate, the parent has an interest which terminates upon death. At that point in time, the child, who owns the future interest, becomes the owner of the property as a matter of law without the need to probate the estate.
However, the value of the real estate is included in the taxable estate of the parent for estate tax purposes, even if there is no need to probate the estate. This normally works to the advantage of the children, as they receive what is known as the step-up in basis of the real estate. The benefit is that they inherit the property at the date-of-death value, not the value as of the date of the transfer nor the date upon which the parents acquired the property.
If the parents’ total assets exceed the estate tax credit for estate tax purposes, then the value of the estate, together with the real estate, will cause an estate tax to be due. In Massachusetts, as in many other states, when a person dies owning any interest in real estate, there is an automatic lien, which attaches to the real estate, which must be released by the filing of an estate tax return within nine months of date of death or an affidavit when no tax return is due.
This usually is a mere formality if there is no tax due, but it is necessary to clear the title of the property for the children. In some jurisdictions, such as Connect-icut, a gift tax may be due upon the transfer of the real estate.
Impact on Medicaid Eligibility
Secondly, the transfer of the real estate to the children triggers the waiting period for Medicaid eligibility. Without providing all details relative to the rules and regulations of the Division of Medical Assistance (which administers the Medicaid program in Massachusetts), suffice it to say that this transfer will ‘start the clock ticking’ on the transfer period, which may be up to three years.
Subsequent to the possible three-year period for ineligibility for obtaining Medicaid benefits, the property should be exempt such that the Division of Medical Assistance will not obtain a lien on the property for the value of services rendered, in the event that the grantor was a recipient of Medicaid eligibility in the Commonwealth.
However, the state may place a lien on the property, but the lien normally is extinguished upon the death of the Medicaid recipient, so long as the property is not sold during the lifetime of the Medicaid applicant. +
Naturally, this rule is subject to change, and if it does, one may wish to revise the plan of utilizing this type of transfer. In some jurisdictions, the transfer waiting period may be extended if the proposed rules are enacted as to this disqualification period.
The third benefit is that the elder person, who is the person reserving the life estate, will be entitled to obtain an abatement for real estate taxes if he or she otherwise qualifies for the abatement within the city or town. There is an income test, as well as an asset test, in order to qualify for this exemption, but it is preserved so long as the person living in the house (the grantor) reserves the life estate.
Naturally, whenever there is a benefit, there is also a detriment or downside. In the event that the future interest holder dies, becomes disabled, gets divorced, has tax liens against him or her, or incurs significant liability, then his or her interest in the property may be attached by the creditor having such claim.
Also, in the event that the child should die, his or her will, if not revised, may leave these future interests in the real estate to his or her spouse and/or children. In a similar manner, this person may die without a will, which causes substantial adverse consequences in many cases. Also, if the property is sold during the lifetime of both parties, there may be a capital gains tax assessed against the children for their share of the gain, which they receive as a result of the sale. The parent should usually be entitled to the exemption for the exclusion of being taxed on the capital gain on the sale of a principal residence.
While this article is not intended to be a complete and total explanation of the technique of a life interest, hopefully it will promote awareness of this often-beneficial means of transferring the real estate to the next generation. As always with these types of transfers, it is best to consult a professional who has the expertise in both the legal and tax areas prior to making the final decision to transfer the real estate.
Hyman G. Darling, Esq. is chairman of the Estate Planning, Elder Law Department at Bacon & Wilson, P.C. in Springfield. Recognized as the area’s preeminent estate planner, his areas of expertise include all areas of estate planning, probate, and elder law; (413) 781-0560.