The Ins and Outs of Reverse Gifting

Q. My daughter started her own business and made some good investments with her money, and became very successful. She recently told me that she wanted to transfer assets to my name to assist me with my living expenses, but she wants to give me a brokerage account with stocks worth much more than I ever see myself needing. She’s also talking about gifting me a rental property that would help provide me with extra monthly income. I don’t really think I will need all this extra monthly income (unless I have to go into assisted living or a nursing home), but my daughter says that even if I don’t need it, it would help her reduce her income taxes that would otherwise need to be paid. I trust my daughter, but I don’t understand how any of this works, or whether this is a good idea. Any light you could shine on this topic would be greatly appreciated!

A. When we think of transferring assets between generations, we tend to think of parents giving assets to their children, but that’s not always the case. Many adult children support their parents financially by making gifts to them, or by paying for their basic living needs and/or long-term care needs. And sometimes, an adult child transfers real estate and/or appreciated stocks to their parents solely in hopes of achieving significant tax savings when the parent dies and leaves those appreciated assets back to the child.

What your daughter is thinking of doing is using a strategic tax planning technique often called “reverse gifting,” which typically involves the transfer of real estate or appreciated financial assets from a child to a parent, with the expectation that the parent will leave those same assets back to the child upon the death of the parent.

How Common Is Reverse Gifting to Help Senior Relatives?

Recent studies have indicated that many seniors are requiring assistance — in some cases, from their adult children and relatives. According to a study conducted by Employee Benefit Research Institute (EBRI), nine in 10 retirees and those approaching retirement consider Social Security a major source of income. Social Security is often not sufficient to live on, so these seniors may need additional assistance to make ends meet.

According to TD Ameritrade, one in five millennials and Gen Xers who are financially successful say they are currently helping or expect to help supplement an older loved one with expenses during retirement. For many, the help involves reverse gifting.

The Many Potential Tax Benefits of Reverse Gifting

Although some children choose to simply help support their parents by gifting cash assets to their parents so that their parents can pay their bills, there is no tax benefit to doing this, whereas there are many other strategies under the umbrella of “reverse gifting” that can result in significant tax savings for the child.

Reverse Gifting to Get a Medical Expense Deduction

If a child directly pays the bills for a parent, including medical bills or long-term care expenses, there is a possibility that the child could claim the parent as a dependent, thus allowing the child to claim a medical expense deduction for the parent’s medical bills and/or long-term care expenses on the child’s tax return, which can considerably reduce the child’s income tax obligation.

Reverse Gifting to Get a Step-up in Basis

There can also be significant income tax benefits, in the form of capital gains tax avoidance, when a child transfers appreciated assets, such as stocks and real estate, to a parent (or other senior relative):

  • When an adult child pays higher income tax rates than the parent, transferring highly appreciated assets to the parent in a lower income bracket can provide the following benefits:
    • The parent could sell the assets at lower capital gains tax rates; or
    • If the parent doesn’t need the assets for living expenses, the parent can simply hold onto the assets until the parent dies and the child who gave the assets to the parent can inherit those assets upon the parent’s death.
      • The child’s inherited real estate or securities would then receive a full step-up in basis as of the date of the parent’s death (so long as those securities or real estate were held by the parent for at least one year after transfer, meaning the parent does not die within one year after receiving the transferred assets from the child — see — page 10.
      • The child who receives the appreciated assets from the parent upon death should then be able to sell the assets promptly with no capital gains tax due.
      • Let’s look at a very simple example: Susan, Jane’s daughter, owns her home that she purchased 25 years ago for $200,000, and that home is now worth $800,000. Susan is 60 years old, and her mother is 87 and in somewhat failing health. Susan is thinking of selling her home in the next five years or so and moving to a warmer climate but is worried about having to pay a significant capital gains tax when she sells. Susan is not married, so if she were to sell her home, she would be faced with a capital gain of $600,000 and only a $250,000 capital gains exclusion for selling her primary residence, so she would have to pay capital gains tax on $350,000 of gain. Given a federal capital gains tax rate of 15% and a state capital gains tax of approximately 5%, Susan’s capital gains tax bill would be approximately $70,000. Susan can potentially avoid this $70,000 of capital gains tax by strategically using reverse gifting. Using this strategy, Susan has her attorney prepare a deed of gift transferring her home to her mother. Jane then has her attorney prepare a trust or other document that transfers this house back to Susan upon Jane’s death. So long as Jane lives for at least one year after receiving the gift from Susan, then when Susan inherits the property from Jane, Susan will receive a full step-up in basis, so that Susan’s tax basis jumps from $200,000 to $800,000 (or possibly even higher if the property has continued to appreciate in value — Susan’s tax basis will be whatever the fair market value of the property is at the time of Jane’s death). This exact same scenario could play out with stocks that Jane purchased for $200,000 that had appreciated in value to $800,000 prior to Susan gifting those stocks to Jane.

Gift and Estate Tax Implications of Reverse Gifting

When it comes to reverse gifting, or gifting in general, it’s important to understand the potential gift tax and estate tax implications, though for 99 percent of the population, these considerations are meaningless. Individuals are allotted a “lifetime exemption amount” for gift taxes and estate taxes, which applies to both lifetime gifts and gifts made at death. As of 2022, the “lifetime exemption amount” is $12.06 million for an individual, and double that for a married couple. Gifts or transfers made in excess of this limit are taxed at a whopping 40 percent gift tax rate but, as mentioned, this is irrelevant to 99 percent of the population, who have estates well below the $12.06 million exemption. This lifetime exemption amount is scheduled to be reduced to approximately $6.5 million per person in 2026, still vastly more money than most people have.

Every individual is also allotted an “annual exclusion” gift amount (currently $16,000 per individual per recipient), which doesn’t count against your lifetime exemption. This does not mean you can’t give away more than $16,000 per year to an individual; it simply means that if you do give away more than $16,000 per year to one individual, you need to file a gift tax return showing that you made a gift that is potentially taxable. This gift will never actually be taxable during your lifetime or upon your death unless you give away, during your lifetime and/or upon your death, more than the lifetime exemption amount — it concern not relevant to 99% of the population.

Complex Issues with Reverse Gifting

There are also some complex issues that anyone should consider prior to utilizing a reverse gifting strategy:

  • The making of a gift by definition transfers ownership. This gives the recipient of the gift the legal right to sell the property and spend the money, give it away, or pass it on to someone other than the original owner.
  • Property could also be lost due to legal action against senior relative or divided due to divorce.
  • The biggest concern with reverse gifting is that property gifted to a parent is property that might have to be used to pay for nursing home expenses or other long-term care expenses, thus depleting the assets gifted.

For all of these reasons, you should of course have a high degree of trust in the parent receiving the gift, and a strong reason to believe that your parent will not need to deplete your gifted assets to pay for nursing home costs or other long-term care expenses.

A Better Alternative

If you’re like most people and you are concerned that your parent might need nursing home care before death, and therefore might wind up having to deplete your gifted assets, then it would be extremely wise to consider asking your parent to set up our Living Trust Plus® asset protection trust, a specially designed irrevocable asset protection trust that protects your parent’s assets from probate PLUS lawsuits PLUS Medicaid (subject to Medicaid‘s five-year look-back period), PLUS Veterans Aid and Attendance if your parent was a wartime veteran or is the surviving spouse of a wartime veteran (subject to the VA’s three-year look-back period). With the Living Trust Plus®, your parent would give away ownership of the gifted property to the trust but can retain full investment control of the trust assets by being trustee of the trust.

The Living Trust Plus® irrevocable asset protection trust will protect the assets gifted from you to your parent from lawsuits, medical bills, bankruptcy, etc. Because your parent can’t take the property back after your parent transfers ownership into the Living Trust Plus®, your parent’s creditors also can’t reach the property.

The Living Trust Plus® also enables your parent to qualify for government benefits. Assets that your parent owns count against your parent for purposes of qualifying for certain government benefits, including Medicaid and Veterans Aid and Attendance. As mentioned, the Living Trust Plus® protects your parent’s assets from lawsuits, medical expenses, and — most importantly for the 99 percent of Americans who are NOT among the rarified ultra-wealthy — from the devastating costs of nursing home care.

Get Your Estate Planning Documents in Place to Protect Yourself and Your Loved Ones

Here at the Farr Law Firm, we can help you and your parents create and implement the best type of estate and tax planning for your situations. Reverse gifting is a very simple yet very powerful tool in many situations. Combined with a Living Trust Plus®, reverse gifting can be one of the most powerful tools for asset protection and tax avoidance for 99 percent of the population. If you’re a potential client who would like more information about reverse gifting and/or the Living Trust Plus®, please call our office to make an appointment for a no-cost introductory consultation.

Estate Planning Fairfax: 703-691-1888

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About Evan H Farr, CELA, CAP

Evan H. Farr is a 4-time Best-Selling author in the field of Elder Law and Estate Planning. In addition to being one of approximately 500 Certified Elder Law Attorneys in the Country, Evan is one of approximately 100 members of the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys and is a Charter Member of the Academy of Special Needs Planners.