Many seniors look to provide for their family by transferring their home to their children. The home often represents a family’s largest asset, as well as a significant investment both financially and emotionally that parents want to keep in the family. However, transfers of real estate among family members can have adverse tax consequences if not done carefully. Seniors who may need to qualify for MassHealth or other benefit programs should be particularly aware of the potential consequences of such a transfer.
No one wants to pay more than their fair share of taxes, and one of the principal goals of estate planning is to minimize an estate’s tax exposure. One important category of tax for potential home sellers to be aware of is the tax imposed on capital gain. Capital gain is the difference between a home owner’s costs (generally the initial purchase price plus capital improvements) and the amount realized for the sale of the home (generally the sale proceeds). Unless subject to an exception in the tax code, the entire amount of capital gain will be taxed.
An individual homeowner can avoid capital gains tax on up to $250,000 of gain ($500,000 for married couples) if they owned and occupied the property as their principal residence for two of the last five years. This exclusion can be applied to only one sale of a principal residence every two years.
The occupancy requirement for this exemption looks at the aggregate time occupied, rather than a continuous two years, allowing seniors and those involved in MassHealth planning to benefit since they are not penalized for having to leave their residence for health care. In fact, a homeowner who resides in a licensed health care facility in Massachusetts is able to claim this exemption even if he or she used the home as their principal residence for only one of the previous five years.
However, transfers of a senior’s principal residence to a related party, such as a spouse or child, lose this exemption. Even if a parent sells a remainder interest to a child while retaining a life estate, they must report any gain on the sale. Complicating this transaction further is the fact that the IRS characterizes remainder interest sales between parents and children as gifts. In such a transaction, the parent will be deemed to have made a gift to the child of the full fair market value of the property, less the consideration paid. This could potentially expose the parent to both capital gains and gift taxes on the same transaction.
Furthermore, seniors looking ahead to the potential of qualifying for MassHealth benefits must be aware that any transfer of real estate within the five-year look-back period for less than fair-market value will be considered a disqualifying transfer. Funds realized from the sale of a property may also prevent a MassHealth applicant form meeting the financial eligibility requirements.
For these reasons, if the primary goal of a senior is to transfer their home to their children while minimizing tax exposure, the use of an irrevocable trust may be a good option. In a trust, the property would pass to the next generation upon the death of the homeowner while avoiding probate, and would also avoid being treated as a capital gain of the beneficiaries.