Should I pay off Mom & Dad’s mortgage?
My parents, who are in their 80’s, are still paying a mortgage on their house. I am considering paying off the mortgage myself and putting the title of the home under my name so my parents do not have to worry about this anymore. Is this a good plan?
While paying off your parent’s mortgage may get you nominated for “Best Child of the Year,” there are some serious disadvantages that you may want to consider.
Medi-Cal covers the costs of things that Medicare does not cover, including prescription medicines and nursing home care. With skilled nursing facility care costing well over $9,000 per month, this is a substantial out-of-pocket cost for many. Currently, a recipient’s personal residence is exempt from the property limits that Medi-Cal uses to determine eligibility.
This means they won’t make Mom and Dad sell the house in order to qualify.
However, there are rules in place that prevent folks from transferring all of their assets just to qualify for Medi-Cal. So, if Mom and/or Dad were to ever need Medi-Cal within 30 months after they had transferred the title of their house to you, they will be ineligible for those benefits. They will have to pay for the care out-of-pocket, at $9,000+ per month, for 30 months, before becoming eligible for Medi-Cal nursing home care.
You may be familiar with the concept of a tax basis. Basically, the tax basis is the value of the asset at the time of purchase (generally that value is also the cost). Let’s say Mom and Dad paid $200,000 for the house, which means their tax basis is $200,000. Should your parents sell their house today, presumably the house has substantially increased in value. If they sell the house for $1,000,000 today, they will have to pay capital gains taxes on a portion of the $800,000 increase (only on part because there is an exemption of $500,000 for married couples).
If Mom and Dad simply transfer their home to you during their lifetime, you get their tax basis of $200,000. When it comes time to sell, it may cost you. If you do not live in the home, using it as your personal residence for two of the last five years, you will not even have an exemption for any part of the increased value and you will probably have to pay a substantial sum in capital gains taxes. Even if you make the house your personal residence, if the house sells for $1,000,000, you only get to exempt part of your gains (up to $500,000 if you are married). There is a very good chance that you will have a tax liability if they transfer the house to you now.
However, when a person inherits a house, they get a “stepped-up tax basis” based on the value of the house as of the date of death. So, when you inherit the house your parents paid $200,000 for, the value of the house might, for example, be $1,200,000 as of the date of death. That $1,000,000 in gain is irrelevant. No one pays taxes on it. Because you inherited the house, you get to use the stepped-up basis of $1,200,000 when you sell the house. Since many homes are sold shortly after death, you will probably not have any capital gains liability.
Another disadvantage of transferring the property to your name is that the property becomes your own asset. Your assets are subject to liabilities that you may not have considered. If you were ever named as a defendant in a lawsuit and a judgment was entered against you, then your parent's home could be in jeopardy. Their home could also be in jeopardy if you had to file bankruptcy.
One more thing to consider is your siblings. How are they going to react when they learn that you are now the homeowner and they are essentially losing their inheritance? What type of family strife is this going to cause? The worries your parents have about the mortgage are probably nothing compared to angry and upset children.
You should consider paying the mortgage for your parents instead of transferring the title. If your parents wish to repay you, they could consider returning the funds to you after they have passed away. With the help of an estate planning attorney, their trust can include such provisions. When an estate plan is prepared, the estate gets divided in the manner dictated by the owner.
The enormous tax benefit that heirs receive through the stepped-up tax basis should give you pause before transferring the property during your parent’s lifetime. If Mom and Dad prepare an estate plan, they can provide for a quicker transfer of their assets and distribute the assets as they wish, while avoiding a lengthy probate of the estate. Some of the many advantages to an estate plan can be found on my Estate Planning page.
Assuming one or both of your parents did need to use Medi-Cal during their lifetime there will be a bill to be paid by their probate estate. This process is called Medi-Cal Estate Recovery. If their home is not in a trust, the state will demand repayment upon the death of the surviving spouse when the family goes to probate the estate.
By preparing an estate plan, Mom and Dad’s house will be put into a revocable living trust and it will not be subject to the Medi-Cal Estate Recovery.
If you or your parents would like to discuss these issues further, I would be happy to provide a free consultation.