Gifting Assets to Protect from Long-Term Care Costs
In prior posts, we discussed Long-Term Care (LTC) costs and the risks that those costs can have on keeping farm assets in the family. For those people needing LTC, the average cost is around $150,000. However, some people will require nursing home services for many years which could cause costs to be $500,000 or more. A strategy some people implement to protect their assets from LTC costs is gifting. We will discuss both the advantages and disadvantages of gifting.
The idea behind gifting is to transfer the assets to children or other beneficiaries before the assets must be spent on LTC costs. The person transferring the assets is intentionally trying to make themselves lack the resources to take care of themselves and rely on Medicaid to pay for their care. This strategy sounds simple, but it has many aspects, both good and bad, that must be considered.
First, Medicaid imposes a penalty for improper transfers. An improper transfer is any transfer of an asset for less than fair market value. Medicaid looks back five years for any improper transfers and disqualifies the applicant for one month for each $6,905 of improper gifts made. Improper transfers prior to the five-year lookback period are not penalized.
For example, if a gift of $100,000 was made in the last five years, the applicant will be ineligible for Medicaid for 15 months after application. If a gift of $1,000,000 was made, the applicant will wait five years to apply for Medicaid and then will not be required to report the gift because the five-year penalty period expired.
In addition to overcoming the five-year look back period, making a gift requires the owner to give up all ownership and control, including income produced by the gifted asset. This creates the risk that the original owner cannot protect the gifted asset from financial or legal mishaps of the person receiving the gift. This risk is a significant factor that should be considered when contemplating a gift.
Consider the following example. Dad owns 200 acres of land and is concerned he will be forced to sell the land if he incurs LTC costs. To protect the land, Dad gifts the land to Daughter. After Daughter receives the land, she causes an automobile accident and is liable to the injured party for $1,000,000. Her auto insurance only covers $250,000 in liability so she must sell some of the land received from Dad to pay the injured party.
This example illustrates the risk of giving up ownership and control of assets when gifting. In future articles we will discuss strategies to overcome this risk using irrevocable trusts and/or LLCs.
Tax implications are another factor to consider when gifting. The IRS allows large gifts to be made without a gift tax being owed provided a gift tax return is filed. Instead of taxing the gift, the IRS reduces the giftor’s federal estate tax exemption by the value of the gift which is reported on the gift tax return. Also, the person receiving the gift receives the same tax basis as the giftor rather than receiving a stepped-up tax basis to fair market value if they were to receive the same asset as an inheritance.
Using the same example as above, the value of the land gifted to Daughter was $2,000,000. Dad would file a gift tax return and his federal estate tax exemption would be reduced from $12,060,000 to $10,060,000. No tax is owed but Dad’s estate exemption limit is reduced by the amount of the gift. Let’s assume Dad paid $200,000 for the farm when he first bought it. Daughter will receive the farm with a $200,000 tax basis. If she would have inherited the farm instead, she would have received the farm with a $2,000,000 tax basis. The loss of stepped-up tax basis when gifting is a significant factor to consider.
For a thorough discussion on the tax implications of gifting, see the law bulletin “Gifting Assets Prior to Death” at go.osu.edu/farmplanning.
The biggest benefit of a gifting strategy is its simplicity. Land can be transferred with a simple deed, money can be transferred by check, and machinery and livestock can be transferred with simple paperwork. It is usually relatively easy to transfer assets by gift. Also, the gifting can be done quickly to get the five-year lookback period started.
Gifting assets is one of several strategies to protect assets from LTC costs. While the process of gifting is relatively easy, the implications of gifting are significant and extensive. Anyone considering a gifting strategy to protect assets should consult their legal and tax advisors to determine if gifting is the best strategy.