This column first appeared in the MySA Express-News on December 11, 2014.
Dear Mr. Premack: My wife, as Grantee on a Lady Bird Deed, received ownership of her parents’ house after her mother’s death earlier this year. Her father is in a nursing home with no possibility of ever going home. Intentions are to sell the property upon her father’s death so that his desires of sharing the estate with two other siblings can be accomplished. My question to you is when she sells the property, will she be liable for the capital gains taxes since the deed is now under her name? Is there an option for her to take to avoid paying these taxes? Will it affect our personal tax liabilities? – FT
A Lady Bird Deed is a property ownership arrangement under which two legal actions take place: 1) the property owners retain life estate while granting to someone else (like your wife) the remainder interest, and 2) the property owners retain the legal right to rescind the remainder interest to recapture full ownership of the property. This right to rescind is what distinguishes a Lady Bird Deed from a standard Life Estate Deed.
Why do Lady Bird Deeds exist? Primarily for one reason: to prevent a homestead from falling prey to the Medicaid Estate Recovery Program (MERP). Your wife’s parents seem to have had exactly that intent when they signed the Lady Bird Deed, and you are concerned additionally about the tax ramifications when your wife eventually sells the property.
Before we get to the tax ramifications, it is important to understand that your wife does not yet own her parents’ house. Her mother and father signed the Lady Bird Deed. Later, her father moved to a nursing home. Later, her mother died. The home was her parents’ community property, owned 50-50 by them both. When they signed the Lady Bird Deed, they were not vesting ownership solely in your mother in law’s name; rather, their 50-50 ownership was converted into a lifetime interest with the requirement that only when both of them die title would vest in their daughter (your wife).
Consequently, after your mother in law died, your father in law continued to own life estate in 100% of the property. And since this is a Lady Bird Deed, your father in law still holds the right rescind. It is his homestead. It is exempt for Medicaid purposes. The house continues to receive the 65+ property tax exemption on his account. It is only upon his eventual death that the life estate will expire – assuming that he has not rescinded – and then the remainder interest blossoms so that your wife becomes full unrestricted owner of the property. She will need to work with an attorney to file proper documentation with the county clerk’s office.
When she becomes full owner, she is treated as having inherited the property from her father (the second spouse to die). She plans to sell the property so the net proceeds can be split equally between her and her two other siblings. Will she be liable for capital gain taxes since the house was in her name? Yes. However, she will receive a free step-up in basis on the house to its market value on the date of her father’s death. If she sells the house promptly, it is likely that her basis will be equal to the sales price, which means that the capital gain will be zero and the tax will be zero.
The larger concern should be with gift taxes. She will receive full ownership of the house when her father dies. When it sells, she wants to split the money with her brothers. Let’s say that the house sells for $200,000. She will be gifting $66,666 to each brother. This is a gift from her, not from her parents.
She is allowed to gift up to $14,000 in a single year to each brother without having to inform the IRS or to pay gift tax on the transfer. Any gift over $14,000 in a year will require her to file a gift tax return. She will be required to pay the gift tax unless she draws on her lifetime exemption when she files the gift tax return. She should thus consult with her CPA and her Estate Planning Attorney to be sure she files the correct return and that using her exemption will not negatively affect her other estate planning goals.
Paul Premack is a Certified Elder Law Attorney with offices in San Antonio and Seattle, handling Wills and Trusts, Probate, and business entity issues. View past legal columns or submit free questions on legal issues via www.TexasEstateandProbate.com or www.Premack.com.