Should you give your house away?

June10, 2016

It sounds like a strange question, but sometimes you should.

When would that be? There are several situations in which you should consider it and, based on my experience, here are a few case studies.

Sally Smith (not her real name) is knocking on the door of 90 years of age. She’s in great shape and a few years ago, with the help of a terrific tax attorney, she put her home and some of her liquid assets into a “family” trust.

She was widowed a few years earlier, and, like many seniors, mama took care of the home and papa took care of all financial matters. So, when papa died, mama needed a lot of handholding and support, which she got from her family and her lawyer, as well as her financial advisor and his staff. Fortunately, Harry (not his real name) left Sally (reminds me of the movie when “Harry Met Sally” with Billy Crystal and Meg Ryan) with more than enough money to take care of her needs during her lifetime.

So the challenges became: 1. How do we make sure that Sally is taken care of for the rest of her life? 2. How do we minimize risk for Sally during her lifetime? 3. How do we minimize taxes on the transfer of assets to the next generation?

Let’s begin with the first question. How much money will Sally need to live on comfortably for the rest of her life? This is determined by running a cash flow from now until age 100 (we can make it 110 when she makes it to 100) which considers living expenses, inflation, taxes, and the vagaries of investments. Computers do this for us.

This gives us a number as to how much she needs and how long she will need it. Based on this information, we build and manage an investment portfolio for her.

Question two addresses the risks she faces. General financial planning concepts say that we all face six risks—you can become ill or disabled, you can die, your property can be damaged, someone can sue you and, lastly, you can wind up in a long-term care institution.

Sally’s biggest risk, which all seniors face, is the last on the list: Winding up in a long-term care facility. The going rate around here is about $140,000 per year and, according to the U.S. Department of Health and Human Services, 40 percent of people over age 65 will spend some time in a long-term care institution.

The best protection against a long-term care stay is long-term care insurance. Sally and her husband neglected to buy it when they were younger; therefore, it would be very expensive to buy a policy at her age, so we considered another route. By putting her house and most of her assets into the family trust, after five years, if she went into a facility, she would be eligible for Medicaid. Prior to the end of the five-year look back provision, she would have to pay with her own assets, which is why we didn’t put everything into the trust.

Putting her home and some other assets into the family trust will also help out with question three—transfer taxes. New Jersey is one of two states that have both an estate tax and an inheritance tax (the other is Maryland). So, a simple way to avoid these taxes, which begin on assets over $675,000, is to put your home and other assets into a trust so that taxes are not payable at the death of the owner.

Another good option to give your house away is through a Charitable Remainder Trust (CRT). This can work out quite nicely because: 1. You get the house out of your taxable estate. 2. You get an income stream for life. 3. You avoid the recognition of capital gains on what could be a highly appreciated asset, and 4. You receive an immediate income tax charitable deduction based on a portion of the property’s value.

With those four benefits, this is a win, win, win, win for you and the charity. However, it is a loss for your heirs. Not to worry, this can be easily replaced by purchasing a life insurance policy, or, better yet, have the trust purchase the policy. When a trust purchases the policy, there are no taxes due on the proceeds. This way, your heirs are compensated for the house that they lost because of your largess, by receiving non-taxable cash at your death.

The life insurance purchase creates a fifth “win” in this situation.

This is a hypothetical example and is not representative of any specific situation. Your results may vary. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for the individual.

Randy Neumann is a financial professional with and securities offered through LPL Financial, member FINRA/SIPC.