To donate? OR Not to Donate? …… That is the Question.
Donations are a very common tool used & associated with Estate Planning. However, if done improperly or without proper guidance, donations can have major consequences.
In addressing the issues in Donations I separate them into three different concerns. Those three concerns that I bring up to my clients when they inquire about donating a property are; ownership, taxes and Long term care (nursing homes).
You lose it, regardless of what you have been told, the moment you donate property you are no longer the owner. Even if you reserve that fancy term we use in the legal profession called a “Usufruct” you no longer have full ownership of that property. Meaning, should any of the people you donated that property to go through bankruptcy or divorce, it might potentially become part of those proceedings or be subject to liens.
Taxes are probably the biggest potential downside to donations & often are the least talked about. There are two main branches of taxes that come into play with the donation of property, cost basis & gift taxes, with the former being the bigger issue and the one I will cover today.
Cost Basis, what is it and why is it a big deal? Cost Basis is the calculation of gains & loses on a property as determined for Capital Gains Tax purposes. Cost Basis has become a very important part of Estate Planning, with Estate Planning Attorneys trying to find the best plan possible for their clients while allowing property to still receive that “Step Up” in basis for Capital Gains Tax purposes.
So, why is that a big deal in donations? Well, donated property does not benefit from a “Step Up” in basis for Capital Gains Tax purposes. Meaning, the person receiving the property inherits the basis at what the donor (original owner) paid for it minus any adjustments made.
What does all this mumbo jumbo mean? Well lets look at an example, examples always help me so hopefully they will help you.
Example 1: Lets say a mom donates to her son a home worth 400,000 dollars. Mom paid 100,000 dollars for the home over 20 years ago and since then has added 50,000 dollars worth of improvements. If the son goes to sell that property at 400,000 dollars he would have realized a 250,000 dollar capital gain and will be taxed on the entirety of that 250,000.
Example 2: Now lets say mom had a living trust or a testamentary estate plan. When she passes away her son will receive that property, whether out of the living trust or through the succession process. At that time the son comes into possession of the property it is valued at 400,000 dollars. Well because the property was transferred after death via a living trust or testamentary estate plan, the son will benefit from the “Step Up” in basis for capital gains purposes. Meaning, if the son went to sell that home, valued at 400,000 for 400,000 dollars he would pay ZERO dollars in capital gains tax and get to keep the entirety of that 400,000 dollars.
In either of the above examples the son will receive a 400,000 dollars asset however, in the latter, you give ZERO dollars to the IRS.
Long Term Care (medicaid/nursing home)
Frequently, I will review donations done years ago that were done for the purpose of protecting that asset from the “Nursing Home.” This is a very common occurrence in my office. Unfortunately the vast majority I review are done incorrectly. Why? Well as stated earlier, a very common tool used in a donation style of planning is the reservation of a usufruct in favor of the Donor of the property. This language, meaning use of fruits, allows the Donor to retain the right to use and benefit from the property. This is extremely common on Non-Homestead property such as, farmland, rental properties etc.
However, this can cause problems if the donation was done for the purpose of protecting the asset from long term care expenses. The reason, medicaid who is the governmental program that pays for long term care, will recognize that usufructuary interest as an ownership interest. Meaning, the “Look Back” period never started on that asset regardless of how long ago you completed the donation and they will apply a value on it according to their own usufructuary value chart.
Estate Planning & Elder Law Attorney
Mahtook & LaFleur
“Planning Estates & Preserving Legacies”
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