For years people have tried to transfer wealth before death. There are many reasons for doing so but often the main motivation was estate tax avoidance. Now, with changes in tax law and very high exemptions, most people will not pay any estate tax upon death. A more recent motivation has been Medical Assistance laws. If the County pays any nursing home care they will have a lien on your assets that must be repaid at death. If you gift assets five years before needing such assistance, these assets would not be subject to that county lien. There are, however, several concerns with gifting before death.
Another tax that receives much less attention is capital gains tax. In short, if you buy a parcel of land, for example, for $50,000 and later sell that land for $100,000, you would have a $50,000 capital gain that would then be taxed in the year of sale. There are several exceptions to this rule. One exception that many have used is the homestead exemption – part of the sale proceeds are exempt if assert the land was your homestead. Another is to sell the land as part of a 1031 exchange. In that exception, you don’t touch the sale proceeds but instead direct your closing company to purchase a replacement property with those funds – this would defer any gain until you sell the replacement property. The last major exception that applies to gifting is the step-up rule. If you keep that $50,000 parcel of land until death and it is worth $100,000 at death, your heirs can then sell this parcel for $100,000 and have no gain as the basis steps us to the value upon death. This is a major reason to potentially not gift during life. If you transfer that same parcel during life, your heirs assume your basis in that parcel so whenever they sell they would have the same capital gains issue you do.
Another concern with gifting is simple loss of control, use and income. Many parents assume that they can transfer title to a parcel of land to their children but keep the rental income. That income is now the child’s money. Parents also trust that children will hold on to the asset just in case you need to sell that asset in a pinch later on. Again, title matters, once a child owns that assets it is subject to their divorce, death, creditor problems or just a safety net when the child gets in a pinch. These concerns multiply if the asset you gift is something you can’t live without – your homestead for example.
When you make a larger gift during life, you might have to file a gift tax return with the IRS. And, if you need medical assistance within five years of a gift, the gift will disqualify you for a certain time period from receiving assistance. The concern here is that you really can’t predict when you may need medical assistance.
The point of this article is to pause before gifting. Everyone worries about the high costs of nursing home care. Not everyone, however, will need such care and there are clear consequences of gifting assets.
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