When used properly, lifetime gifting can be a useful tool for protecting and distributing property. When used improperly, however, it can lead to Medicaid penalties and tax consequences.
First, it is important to understand the difference between “gifting” for federal tax purposes and “gifting” for Medicaid purposes. The Internal Revenue Code allows for lifetime gifting of assets up to a certain level without accruing taxes against the gift. In 2020, the lifetime gift exclusion limit is $11.58 million per donor.
The Internal Revenue Code further allows excluded annual gifts of up to $15,000, which allows an individual donor to give gifts to numerous people, so long as the total amount of the gift to any one individual does not exceed $15,000 during the year. Gifts of more than that amount must be reported to the IRS and will be deducted from the total lifetime gift allowance.
Because the current lifetime gift tax exemption is so high, outright gifts during your lifetime can be a simple way to distribute property to beneficiaries – with some exceptions.
Two of the primary problems with outright gifts are the Medicaid lookback period and preservation of the “step-up” in basis.
First, when someone enters a nursing home and is unable to afford the full cost of the facility, loved ones most often turn to Medicaid to cover the cost. In every state but California, Medicaid imposes a five year lookback period upon the applicant. This means that if the applicant has given assets away within the past five years, the value of the asset will be counted as still being an available resource.
Most often, this results in a formula being used to determine a penalty period – a determination that the individual is medically and financially eligible, but is required to pay out of pocket for a specified amount of time before Medicaid will begin to pay.
A penalty period can be useful if intentionally triggered for the purpose of preserving assets. Otherwise, it is usually an unwelcome and somewhat frightening requirement.
A penalty period also is something of a Catch-22, as the applicant is required to pay because he has given away assets, which render him unable to pay.
The differences between the IRS gifting rules and the Medicaid lookback rules are extreme. Well-intentioned families often intentionally give away property, carefully following the IRS annual exclusion amounts, with the expectation that these rules will work for Medicaid planning as well. Unfortunately, they do not.
If the individual remains out of a facility for more than five years after the last gift is made, gifting can still accomplish successful Medicaid planning.
On the other hand, gifts really are gifts and premature planning can leave the donors will limited resources later in life.
The second major problem with outright gifts is the potential loss of the “step-up” in tax basis for appreciating assets.
When an individual purchases an asset, such as stock or real estate, the purchase price is the tax basis. When the individual later sells that asset, the seller will be taxed on the gain. If the asset is real estate and the owner has resided in the property for at least two of the past five years, the gain may be excluded up to $250,000 per owner.
If someone gives the property away during his or her lifetime, the property carries the donor’s tax basis. However, if a recipient receives the property upon the donor’s death, the tax basis rises to the fair market value at the time of death.
This is called a “step-up in basis” and can have tremendous tax savings for recipients. When beneficiaries then sell the property with a step-up in basis, the capital gains are minimal.
Gifting can be a powerful tool for estate planning, but if done improperly, may have unexpected consequences that far outweigh the expected benefits. Consult a qualified professional before making major financial gifts.