Medicaid: The Perils of Gifting FAQ

Updated on 11/28/2022
The Perils of Gifting

In 2024, the IRS Federal Gift Tax laws allowed you to give away up to $18,000 per year to anyone you want without the requirement of filing a gift tax return. This means that you (and your spouse if you are married) may each give an unlimited number of these $18,000 gifts per year. So, for example, if you have four children and eight grandchildren, you could give away up to $216,000 (12 x $18,000) each year without the requirement of filing a gift tax return.However, you must understand that even though the Federal Gift Tax laws allow you to give away up to the annual exemption amount per year to as many people as you wish without gift tax consequences, Medicaid laws still apply to these gifts, meaning that these gifts will result in a penalty period which is a period of ineligibility for Medicaid based on the amount of money gifted. Every state has at least one Medicaid penalty divisor. In the DMV (DC, Maryland, and Northern Virginia area), this penalty divisor is around $10,000 per month which is intended to represent the approximate monthly cost of a room in a nursing home. So, for example, a gift of $200,000 would result in a Medicaid penalty period in the DMV of approximately 21 months, meaning approximately 21 months of ineligibility for Medicaid. And in the rest of Virginia (outside of the northern Virginia area), the penalty divisor is lower, meaning the same gift would result in an even longer period of ineligibility for Medicaid.
No. You are never penalized for giving away more than the annual exemption. You may, if you are very wealthy, owe gift tax (see you next question), but that is not a penalty.
Probably not, unless you have an extremely large estate. The annual gift tax exemption does not mean that if you give away more than the annually exempt amount per year to one person that you will owe gift taxes. On the contrary, cumulative gifts above the annual exemption amount — whether you make those gifts during your lifetime and/or upon your death — of less than the lifetime exclusion (in 2023, $12.92 million per person and $25.84 million for a married couple) will never incur gift or estate tax to the maker of the gift.
No. The recipient of a gift never owes taxes on the receipt of that gift. Gift received are not considered income nor is there any other tax imposed on the recipient of a gift, ever.
Yes. Giving away money to charity is treated the same as giving away money to your children or grandchildren. Even though the IRS rewards you (via a charitable deduction) for making charitable contributions, there is generally no Medicaid exception for gifts made to charity. Many people who apply for Medicaid are horrified to discover that they are penalized for having been good citizens and having given money to charities.
Yes. If a parent transfers assets directly to a child, certain risks must be anticipated: possible lawsuits or other creditor claims against the child; divorce of the child; poor spending habits of the child; the need for financial aid of a grandchild; the loss of step-up in basis for capital gains tax purposes; and the loss of the $250,000 capital gains exclusion if you give away your primary residence.
In 2023, each individual can make cumulative gifts — during life and upon death — of up to $12.92 million per person (double that for a married couple) without incurring gift or estate tax to the giver of the gift. This is called the lifetime gift and estate tax exemption amount.No amount of gift is ever taxable to the recipient of a gift.But remember, as stated above, all gifts are subject to Medicaid transfer penalties if Medicaid is applied for within five years of making a gift.

Loss of step-up in basis for capital gains tax purposes

One of the biggest drawbacks of lifetime gifting is loss of the step-up in basis upon the death of the owner of a home or other long-term investment. Most investors, including owners of real estate, are subject to a 15% – 20% tax rate on their long-term capital gains. However, if an investor or property owner dies while still owning the property, the beneficiary of that property receives a “step-up in basis,” meaning that the tax basis in the hands of the beneficiary after death is the fair market value of the property upon the death of the prior owner. On the other hand, if an investor or property owner gives property away during his lifetime, then the recipient of that gift receives a carryover basis, meaning that the tax basis of the recipient of the gift is the same as the tax basis of the giver of the gift.For example, Mr. Smith, at age 75 and in failing health, worried about the possibility that he may need nursing home care, wanted to protect his house by gifting it to his daughter, hoping he wouldn’t need nursing home care, and therefore wouldn’t need Medicaid, for five years after making the gift. Mr. Smith purchased his home in 1985 for $50,000 and made $50,000 worth of improvements over the years, bringing his tax basis up to $100,000. His house was worth $650,000 in 2020 when he gifted it to his daughter, Joan. Upon the gift, Joan’s tax basis became $100,000 — the same as her father’s tax basis. When Joan sold the house in 2021, after her father’s death, for $650,000, Joan  owed capital gains tax on the $550,000 profit she received ($650,000 sales price minus her $100,000  carryover basis). At a tax rate of 20%, Joan owed capital gains taxes of $110,000.Had Mr. Smith not given his house away to his daughter during his lifetime, but simply allowed her to inherit it upon his death, Joan would have completely avoided any capital gains tax, because her tax basis would have been the $650,000 value of the home upon her father’s death, so her selling the house for $650,000 would have resulted in no capital gain for her.Of course Mr. Smith did not foresee his death one year after giving away his home, as his main concern was winding up in a nursing home and losing his home completely by having to sell it and pay for the nursing home. To protect against this, Mr. Smith could have done things a little bit differently and avoided Joan incurring the $100,000 in capital gains tax when she sold the property.  Had Mr. Smith not given the house to his daughter outright but instead put the home into a Living Trust Plus® Medicaid asset protection, which is designed so that assets are included in the estate of the Settlor, then Joan as the trust beneficiary would have received a step-up in tax basis on the house, up to the fair market value of the house as of her father’s death, just the same as she would have had she inherited the house directly from her father.  A very simple strategy here could have resulted in a significant tax savings.

Loss of the $250,000 ($500,000 for a married couple) capital gains exclusion upon the sale of your primary residence.

Every individual is entitled to a $250,000 capital gains exclusion upon the sale of a primary residence, and this amount is doubled to $500,000 for a married couple selling their primary residence. There is no limit on the number of times that this $250,000/$500,000 capital gains exclusion can be used.For example, Tom and Jane purchased their primary residence in 1990 for $150,000. When Tom was diagnosed with Alzheimer’s in 2019, he and Jane considered gifting their home to their only child, Charles, to protect it in connection with Medicaid and nursing home expenses in the event that Tom were to wind up needing nursing home care. But Tom was in the middle of a divorce at that time, so they decided not to gift the property to Tom. They wound up selling their residence in 2021, at the height of the market, for $750,000, to move into a retirement community. When they sold their home, they made a profit of $600,000. Because it was their primary residence, they were entitled to a $500,000 capital gains exclusion, so they only wound up paying capital gains tax on $100,000, meaning approximately $20,000 of capital gains tax. Had Tom and Jane made the huge tax mistake of gifting their home to their son, Charles, before the house was sold, then assuming Charles sold it in 2021 for $750,000, he would have not received the $500,000 capital gains exclusion because he did not reside in this home. Instead, Charles would have received Tom and Jane’s carryover tax basis of $150,000, meaning that he would have owed capital gains tax on the entire profit of $600,000. At a tax rate of 20%, this means that Charles would have owed $120,000 in capital gains tax, costing the family an extra $100,000 in taxes because of this gift.
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