From time to time I get a question about whether an elderly parent should transfer their home or investment accounts to their children while they are still living. Usually the reasoning is that if they need to go into a nursing home for any length of time, the expenses will drain their assets and there will be very little money, if any, to pass down to their heirs.
Is This a Good Idea?
It depends. Even though this sounds like a straightforward question, it actually brings out a host of long-term care and tax planning issues and could bring some unintended consequences. Before getting into them, let’s review how long-term care costs are covered.
Paying for Long Term Care
Even if they couldn’t say exactly how much it costs, most everyone knows that long-term care (LTC) is expensive. If you’d like to get an idea of costs in your area, here is a good resource (Source: Genworth Insurance). And, although some people still think LTC is covered under Medicare, it’s not unless needed to rehabilitate from an injury or illness that first required hospitalization. For those with general physical or mental decline, these services are not covered by health insurance.
So, whether an assisted living community, a skilled nursing facility (aka nursing home) or full-time home care, the costs are such that needing care for any length of time can have a substantial impact on net worth. This is especially the case for those of modest means who don’t have enough retirement income to cover LTC costs and whose assets usually consist of the home and a moderate amount of savings.
So the individual bears the cost. That is until they no longer can afford to pay for it. Then what happens? State governments step in to help.
States run LTC assistance programs through Medicaid, which means the individual must first qualify as being impoverished. For example, in Virginia, an individual cannot have more than a total of $2,000 in cash, investments and real estate (Source: VA Dept of Social Services). The fear of potentially having to spend down the inheritance to meet Medicaid requirements is why the question about transferring assets comes up.
Transferring Assets and Medicaid – Some Caveats
The strategy of transferring assets to the heirs and then, if LTC is needed in the future, make use of Medicaid, doesn’t seem very complicated. However, depending on the specifics of the situation, there could be several things to consider. I’ve also found some common misunderstandings about Medicaid rules as it relates to LTC as well as potential tax consequences. Here are a few of them.
The Look Back Period
When an application for Medicaid is made, the finances are reviewed. To prevent gaming the system, this evaluation will include looking back in time to see if any substantial assets were gifted. These look back periods vary depending on the state. In Virginia, it’s 60 months. If assets were transferred during the look back period, the state will postpone Medicaid eligibility for the length of time those assets could have paid for LTC services.
Access to Care
Although most LTC facilities and some LTC programs such as adult day care will accept Medicaid patients, they typically limit the number. This is because Medicaid pays less than they receive private pay customers. As a result, the more desirable facilities and programs probably don’t have any open Medicaid slots and may have a substantial (i.e. multiple year) waiting list. This could mean ending up with options that, while meeting state minimum requirements, may not be getting a lot of 5-star Google reviews.
When a gift is made, the original cost of that gift goes with it. This significant detail is frequently forgotten; most gifting is done with cash where the cost of the gift is the same as its value. However, when the gift is something like a home that was purchased 40 years ago or those 100 shares of Amazon bought back in the ’90’s, the cost will be substantially lower than today’s value. So when the asset is gifted and then sold, it generates a capital gain subject to tax. In contrast, if the asset transfers to an heir after death, the cost adjusts to be equal to the current value.
For example, let’s say a parent bought their home 40 years ago for $50,000. The current value is $250,000. If the home is then inherited by the children who sell it, how much tax is due? None. Since the home transferred at death, the cost basis of the home steps up to its current value.
If, on the other hand, the parent gifts the home to their children before death, the cost basis of the home comes with it. Now, when the children sell after the parent’s death, they’ll owe capital gains tax on $200,000 ($250,000 – $50,000 original cost). Depending on their income tax bracket, they could wind up owing up to $47,600 in federal tax plus additional state tax ($11,500 in VA).
My Advice – Get Some Advice
I’ve pointed out a few common considerations when thinking about gifting assets to heirs as a LTC planning strategy. Depending on the situation, there are quite possibly better options. Before taking any action, reach out to some experts. For starters, talk to an attorney who specializes in elder law or estate planning. It would also be good to loop in your CPA and Financial Planner for their input as well. And if you’d like to get an in-depth and unbiased review of LTC facilities and services for your area, resources are available. I wrote about them here.