For a variety of reasons, we often get some form of the following question from our Clients: “Should I just give it all away now?” The answer to that question can be tricky. While it seems like a simple thing to just to sign a quit claim deed to your child, or write a check, or transfer the stock, the consequences can be significant. Therefore, if you want to do any major gift as part of your estate plan, you should consult with qualified professionals about the consequences of that gift. What are some of the consequences?
- You may need the asset in the future. I like to remind people, if you give it away, you give it away. It is no longer yours and you may want it or need it in the future.
- The asset could be lost to your child’s debts. Once your child owns an asset in whole or in part, the asset could potentially be seized to satisfy his or her debts and liabilities. Unfortunately, we have had more than a few clients tell us how their bank account was garnished by a creditor of a child after the child’s name was put on the account.
- Your child may be losing a major income tax benefit. Gifts at death receive what is known as a stepped-up income tax basis, while gifts made during your life do not. For example, if you purchase a parcel of raw land for $10,000, your income tax basis is $10,000. If the land is now worth $300,000 and you give the land to your child during your lifetime, the rule is that your income tax basis “carries over” to the recipient. If they then sell the land for $300,000 they will have $290,000 of taxable capital gain. However, if you wait until your death to give the land away to the child, the child receives a new income tax basis equal to the fair market value of the property. Therefore, if the fair market value is $300,000, the new tax basis is $300,000. If the property is then sold for $300,000 there is no taxable gain. A huge benefit!
- You may be disqualified from receiving Medicaid benefits. One consequence of gifting that is overlooked is the potential loss of Medicaid eligibility. While the specific rules of eligibility vary from state to state, the transfer of assets for less than fair market value within five years of making application for Medicaid can impact eligibility as a penalty period is assessed based on the value of the gift. This could result in a lengthy and potentially permanent inability to obtain Medicaid benefits, without access to the value of the asset that was gifted.
- You may accelerate your Mortgage. Almost uniformly, promissory notes related to a mortgage on real estate have what is known as a due-on-sale clause. Meaning, with limited exceptions, the entire amount owed on the promissory note becomes due upon the transfer of the real estate. If the property is encumbered by a mortgage, investigation should be done on the transferability of that mortgage or the ability of the child to refinance the same.
- You may have to pay a tax. Gifts of sufficient value (currently those in excess of $14,000 per person in a year) can trigger what is known as a gift tax. While initially those excess gifts are covered by what is known as a gift tax exemption (currently $5.45 million) eventually those gifts will actually result in the payment of the gift tax. Additionally, if your estate is large enough, unwise gifts could result in paying estate taxes as the use of your gift tax exemption also impacts your estate tax exemption.
These are just some of the unintended consequences of ill-planned gifting. While gifting can make sense in many instances, proper planning will ensure that consequences are understood and weighed against the benefits.