Source: Texas Realtor Magazine
By Tiffany Dowell LashmetDecember 01, 2020
The transfer of property to an heir does not typically involve a real estate agent. Nevertheless, knowing basic scenarios can help you understand options some property owners may be considering.
Property owners often want to know whether it would be better to transfer property to the next generation or an identified heir while the owner is still living or wait until the property owner has passed away. There are pros and cons to transferring property prior to death, and two other options in Texas may allow a property owner to receive the pros and avoid the cons of a transfer prior to death.
Advantages to Deeding Property Prior to One’s Death
First, it is done and the landowner no longer has to worry about it! It can also allow the property owner the enjoyment of watching the next generation take over and start establishing themselves in a home or begin operating the family farm or ranch.
Second, it allows the property to pass without going through the probate process. Even though the probate process in Texas is not nearly as complex as some other states, it is a process that can take time, effort, and money.
Third, this is a way to get property out of the property owner’s name. This may be important for a number of reasons, including qualifying for Medicaid and avoiding the Medicaid Estate Recovery Program. It would ensure that the asset involved would not be part of the owner’s taxable estate when calculating potential federal estate tax liability. It would also decrease certain expenses for the owner, such as property taxes, since the property would no longer be in that person’s name.
Cons of Transferring Property Prior to Death
First, once the property is deeded, the property owner has no more control, and the deed is irrevocable. This means if the property owner gets angry at the heir, the owner cannot take back the transfer. Similarly, if the heir decides to do something with the property that the original owner disapproves of—like selling the land—the owner has no say over that decision because the land is now owned by the heir.
Second, there are tax implications of making this type of lifetime transfer. If property is deeded during a person’s lifetime, that may have gift tax consequences and may affect the landowner’s lifetime exemption with regard to estate taxes. It is critical that a property owner consult with a tax professional before making a decision to gift during his or her lifetime.
Third, there are potential negative consequences regarding capital gains taxes. Generally, if property is passed by will at a person’s death, the heir receives a step up in basis for capital gains tax purposes, thus likely decreasing the capital gains taxes that would be owed if the property is sold. If property is transferred prior to death, the heir will not receive this step up in basis.
Fourth, this type of transfer could cause several issues related to Medicaid. It could trigger the Medicaid Transfer Penalty. When people apply for Medicaid benefits, one question that they will have to answer is whether they have transferred property for less than fair market value within the last five years. If they have, then they may be ineligible to qualify for Medicaid for a certain period of time. Additionally, the value of the property transferred within that five-year period would be counted towards the value of a person’s assets for purposes of determining whether that person qualify for Medicaid.
Fifth, since the land would be in the name of the heir, it could potentially be subject to any creditors or judgment against the heir.
Alternatives to Consider
In Texas, there are two alternative transfer methods that offer many of the benefits and avoid many of the disadvantages of lifetime transfers. As with anything in the law, there is no “one size fits all,” so anyone considering a transfer would be wise to consult an attorney to determine if these options are a good fit.
These alternatives are the Transfer on Death Deed and the Enhanced Life Estate Deed (also known as the Lady Bird Deed). Although they differ in details, these two deeds are very similar in operation. Both allow the property owner to designate who the property will be transferred to, and deeds are completed and filed during the property owner’s lifetime. For a Transfer on Death Deed, the transfer does not actually occur until the death of the grantor. For a Lady Bird Deed, the grantor would retain a life estate in the property and transfer the remainder interest to the identified heirs but would retain a number of enhanced rights, including the right to revoke the Lady Bird Deed and the right to sell or encumber the property without consent from the heirs.
Both of these types of deeds offer the benefits of a lifetime transfer in that the land will not be subject to the probate process and it is out of the landowner’s name for purposes of Medicaid. They also avoid many of the downsides of lifetime transfers.
These deeds are revocable—meaning that if the property owner decides to “take back” the transfer, the owner can do so until death. For example, if a Transfer on Death or Lady Bird Deed is drafted and filed giving the farm to Child A, but later the parents decide they want to give one part of the farm to Child A and another to Child B, they can simply revoke the previously recorded deed or file a new, modified deed to make that change. Similarly, if the parents initially did a Transfer on Death Deed or Lady Bird Deed to a child, but then decided to sell the property rather than leave it to the child, they have the right to do so.
Second, these deeds do not trigger any gift tax liability. Likewise, these deeds will allow the recipient to obtain the stepped-up basis for capital gains taxes.
Third, these deeds were designed to avoid issues related to Medicaid, so they have the benefit of getting the property out of the owner’s name to allow qualification for Medicaid. These deeds are not considered a transfer to which the Medicaid Transfer Penalty applies. Additionally, since they are not technically part of the grantor’s probate estate, the assets deeded by a Transfer on Death or Lady Bird Deed are not subject to the Medicaid Estate Recovery Program.
Lastly, these transfers will likely protect the property from the heirs’ creditors. For a Transfer on Death Deed, since the transfer technically does not occur until after the death of the grantor, the asset is not subject to claims of the heir since the heir does not technically own the property until the death. For a Lady Bird Deed, were there to be an issue with an heir’s creditor seeking to claim the property, the deed could simply be revoked by the grantor during the grantor’s lifetime.
With estate planning, there are pros and cons to almost every tool. It is important for people to think carefully about the tools that offer the most benefits and the least downsides when making and executing their estate plan. One of the most valuable pieces of advice for anyone considering transferring property to an heir is to work with an attorney to help make the best informed decision from the options available.