Transferring the personal residence: income and transfer tax planning issues for the older client.

• Author: Belkin, Eileen W.

Planning for an elderly client often involves either the immediate or potential transfer of the client's personal residence. The process also often includes considerations other than estate and income tax issues, such as longterm health care (including the potential for nursing home care).

Many methods have been developed to successfully transfer the residence to one's heirs, while at the same time reducing real estate/income tax liabilities.

As is typically true, however, no one method will necessarily accomplish all a client's goals. Instead, the potential results of various methods must be compared in terms of each client's particular situation.

Transfer to spouse

For some clients, it is advantageous for only one spouse to own the residence. For example, an ill or incapacitated spouse may want to transfer the house outright to the healthy spouse for purposes of Medicaid eligibility and/or protection.

If the property is transferred from one spouse to the other, there are no gift tax consequences; Sec. 1041 exempts transfers between spouses from transfer tax. In addition, the transferee spouse will get a carryover tax basis for income tax purposes (Sec. 1015(e)). When the transferee spouse dies, his heirs will get a stepped-up basis in the residence because the residence will be included in his estate (Sec. 1014).

A transfer between spouses preserves the income tax benefits of Sec. 1034 (deferral of gain) and Sec. 121 (the $125,000 exclusion) for the transferee spouse if the residence is sold during the transferee's lifetime.

Transfer to children (or others)

Sometimes a client does not have the option of making a transfer to a spouse, possibly because of death, divorce or the potential incapacity of both spouses. Transfers to others can be achieved by either outright transfers, creation of a joint tenancy, a retained life estate or a retained right to occupy the premises rent free. Trusts may also be helpful in these situations.

In addition to the estate/ income tax results to be considered, a planner must also keep in mind other relevant, nontax issues-such as protection from the transferee's creditors, the possibility of the sale of the property in the near term and the trustworthiness and "good faith" of the transferee(s).

An outright transfer results in a carryover basis for the transferees, with no step-up at the transferor's death (Sec. 1015). In addition, when the transferees sell the house, they will not be entitled to either the...