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For many people, their house, condo or co-op is by far their largest asset. If you bought your home a long time ago, it has probably grown significantly in value.
As you get older, you may start thinking about the next step in your living situation. Your options include:
- Sell your home and downsize, or move to an assisted living facility or nursing home
- Remain in place as long as possible, with help if necessary
- Have a child move in with you, with the possibility of eventually transferring ownership of your home to your child.
There are financial and tax implications of each option. And very importantly, there are steps you can take to minimize taxes and protect the value of your home.
So how should you plan?
Tax laws require you to pay taxes on the increase in the value of your home above what is known as your “basis.” Roughly speaking, your basis is the amount you paid for your home, plus the cost of capital improvements you have made to it. The tax is imposed when your home is sold.
You may be eligible for a one-time exemption of $250,000 for a single person, or $500,000 for a married couple if you sell your home. Read the IRS rules regarding exemptions here.
Let’s use a simplified example to illustrate:
You are single and bought your house 30 years ago for $50,000. You made capital improvements of $50,000 over the last 30 years, so your adjusted basis is now $100,000. The fair market value of the house today is $550,000. If you sold it to move into an assisted living facility, for example, you would owe taxes on the net gain, which is $450,000, minus the exemption of $250,000. That would leave you owing capital gains taxes on $200,000. Can you avoid this result, and what are your options?
- If you transfer ownership of your home during your lifetime, your $100,000 adjusted basis passes to the transferee; this is called a “carryover basis.” And note: If you transfer ownership of your home to your child, and your home is not the child’s primary residence at the time it is sold, the child will not be able to use the $250,000 exemption, and will owe capital gains taxes on the entire gain – $450,000 in the example above.
- If your home passes to your heirs upon your death, your heirs get what is called a “step-up in basis.” That means the basis in the home re-sets to the market value as of the date of your death ($550,000 in the example given). When your heirs sell the home, they would only owe capital gains taxes on the amount by which the sales proceeds exceed $550,000.
Financial Implications and How to Plan
As you can see, it is far more financially advantageous from a capital gains tax point of view for your home to pass to your heirs upon your death. However, if the home remains in your name during your lifetime, its value could be threatened in a number of ways:
- You may be forced to sell or to access the equity in your home in order to pay the costs of your long-term care;
- If you move out of your home and into an assisted living facility or a nursing home, the home will count as a “resource” and may be subject to Medicaid “spend down” requirements;
- In New York, you can receive Community Medicaid benefits while you are living in your home. However, once the home is no longer your primary residence, Medicaid can treat it as a “resource.” Its value will be subject to a possible lien, and you may no longer qualify for Medicaid until you sell it and spend down the proceeds.
Can you do anything about this? In fact, you can. If you transfer your house or apartment into an irrevocable trust, you are no longer the owner – it belongs to the trust. Your heirs can be the Trustees and the beneficiaries of the trust. They will inherit the residence as they would under your Will. If the trust is correctly drafted, you can continue to live in your home for the rest of your life, and your heirs will receive the step-up in basis when they inherit the home.
Creating a trust and transferring your home into it can help you become eligible for Medicaid, protect the value of the home, and provide a maximum level of tax savings for your heirs. If you enter a nursing home, the financial situation is more complicated because of the five year “look back,” but a trust may still be indicated.
Gift and Estate Taxes
Are there gift and estate tax implications if you transfer your residence to a trust? In fact, very few people need to worry about gift or estate taxes.
In New York, there is no gift tax. And as of now, New Yorkers only have to pay estate taxes if the individual’s taxable estate exceeds $5,250,000 (New York State’s threshold is catching up to the federal threshold; details here). Federal Gift or Estate Tax is only owed if your gifts during lifetime and your taxable estate exceed $5,490,000 for an individual and $10,980,000 for a couple; details here.
What about the $14,000 Federal limit for yearly gifts? Gifts of $14,000 or less do not count toward your lifetime exemption from Federal Gift and Estate Tax. Gifts in excess of $14,000 require the donor to file a Federal Gift Tax return, and the first $14,000 of the gift to each person does not count toward the lifetime exemption. No gift taxes are paid until the gifts in aggregate exceed the $5,490,000 federal limit for each individual. As you can see, for most people this will not be an issue!