Q: What is the best way to transfer a secondary residence from an aging father to their children?
We were looking to do a deed transfer, but I had questions of triggering a capital gains tax, or gift tax. I was advised the recipient will inherit the gift giver's tax basis, thus losing the step up in basis at death that would otherwise have occurred, thus creating in most cases a capital gains tax exposure that is much greater than it otherwise would have been. What does that mean?
There was also discussion of the gift creating a very long Medicaid penalty period.
A:
Example: father purchased the property for $50,000 in the 80s. His orignial "tax basis" is $50,000. So that if he sells it for $50,001 he has a gain of $1. Now its 2021 and It is now worth $200,000. The built in gain is $150,000.
If he holds onto the property, either as a full owner, or owns it in a Medicaid Asset Protection Trust (MAPT), with an income interest in the trust for life, then when he dies the kids inherit with a stepped up basis of $200,000, pursuant to Internal Revenue Code Section 1014. If this didn't happen, then the kids, when they sell the property, would get dad's basis of $50,000 (carryover basis), and having a prorata portion of the $150,000 buit in gain. This is sort of like a hidden estate tax but levied through the income tax system as a capital gains tax. Policywise, Congress wanted to avoid that.
However, if instead of dad holding onto the property until his death, he gives away the house the day before he dies (or anytime during life), the kids get a carryover basis. So they have just received a $200,000 house, yes, but they also inherited a built in gains tax on the $150,000 built in gain.
Regarding the medicaid penalty period, well, there is not much you can do there. If he is not about to go into the nursing home, and Oregon allows penalty cures by "giftback" from the MAPT to the kids, then it may be a good idea to transfer the house into the trust. However, if he is going into the nursing home soon, it may be best to take your chances with Medicaid Estate Recovery.
Hope this helps.
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