Legal/Tax structure for rental income paying medical bills

8 Replies

My grandmother is aging and currently in an assisted living facility. In order to cover the cost of her care, my mother has rented out my grandmother’s home. I am trying to help her put the home in the correct entity so she has liability protection yet also minimize taxes. Here are the things to consider

1. My grandmother owns the house free and clear

2. All proceeds from the house will go to her medical expenses, my mother will not keep any herself

3. The house is currently in both my grandmother and mothers name

4. My mother wants to protect her own assets, so I originally recommended an LLC

5. My mother is also a high income earner, and has no real estate of her own to offset taxes

The dilemma - it seems that if the house is held in a single member LLC in my mother's name, she will have to pay taxes on the rent (at a high rate) which cuts into the amount available for medical expenses.

We do not want to keep the house solely in my grandmothers name and risk it getting tied up in probate.

Any recommendations on how to structure this to minimize taxes yet provide adequate liability protection?

Seems like a land trust is the best to protect the Estate. Google Augie Byllot Land Trust (Common Wealth Trust Services) and you will find his company. They can help you to set this up and answer any questions you might have. I tried to post the link here, but it didn't let me. 
Good luck! 

Thank you @Mark Pedroza for always thinking of me.

@Zach Westerfield : Your question has 2 critical concerns that are managed quite differently.

1. Protecting your mother's assets. 

There are a host of ways to limit liability and while putting the home into an LLC sounds attractive, doing so can create unnecessary burdens (higher taxes, higher insurance premiums, etc). I'm not a tax lawyer so I'm not 100% sure of the tax impact on rent collected merely because the property is going into an LLC. Bear in mind that business related expenses may be offset whether or not it is in an LLC. Seek a tax professional if you want to dig deeper.

As for actual liability protection, if the LLC is not run as a true business, then the LLC may not be all that helpful anyway. Many people form entities to hold property with a false sense of security that they are immediately shielded from liability - then later start commingling personal funds, failing to update corporate paperwork and blurring the lines between personal and business matters - all things which erode the LLC protections.

As @Wayne Brooks mentioned, insurance may be adequate but coverage may need to be increased since the property will be rented. I personally would choose to ensure I had more insurance before I created an LLC for a single property.

2. Avoiding probate. 

If you move the property into an LLC, it will avoid probate but there are alternatives. If grandmother creates a revocable trust, she could move her 50% interest into the trust. Upon death, the trust dictates who inherits grandmother's portion of the property - if your mother is the only heir, so be it.

An easier potential solution is to execute a Ladybird Deed (aka Enhanced Life Estate Deed). Essentially, grandmother transfers her interest to "remainder beneficiaries" (your mother) provided grandmother still owns the property upon her death. 

For the duration of her life, grandmother retains a "life estate" and the sole discretion to dispose of her ownership without permission/consent of the remainder beneficiaries. (Think of this like a payable on death beneficiary on a bank account.)

This deed has 2 distinct advantages: (1) Stepped up tax basis and (2) immediately owned by remainder beneficiaries upon death. Avoids probate entirely if done properly.

Hopefully this was helpful - let me know if you need clarification.

LHD

    You need to talk to a CPA before doing any of this. 

    If you or your mother will be inheriting that home potentially you would receive a stepped up basis for taxes- this means that you get it at the current Fair market value. Meaning if it's inherited, and then sold- there should be no gain.

    If the home is transferred to your mother now- that won't happen. So then if she goes to sell it in 10 years for $500k the basis the gain is calculated based on whatever your grandmother paid for it way back whens he bought it. 

    It can create a huge tax difference. 

    Work with an attorney to structure the smooth transition of the property- but taxwise having your grandmother own it until it's passed on via inheritance puts you in a more advantageous spot. 

    Also- Someone is always going to have to pay tax on the rental income. There is no entity or structuring where earned rental income isn't taxed. 

    It also sounds like the rental income being in your grandmother's name will be better tax wise than adding income to your high income mom's tax return at a higher tax rate. 

    There are a lot of elements to consider here you guys should retain an estate planning attorney and CPA

    Thanks everyone for all the advice. I find it very useful. We will be consulting with both an attorney and CPA, I just wanted to do some up front research to have an idea which way to go. here is what I am thinking 

    - place the property in an LLC, with my mother as the manager. I have my own LLC so I am aware of the necessity for it to truly operate as a business in order to maintain its protections. My mom would take a small fee as the "manager", whatever makes sense (5%?)

    - the LLC would be placed in a trust with my grandmother as the beneficiary. My mother would be the next beneficiary.

    this way, my mother gets the liability protection of the LLC, and the trust takes care of probate. from my understanding, my mom would only be responsible for taxes on here "management fee" and the rest of the rental income would be taxed at my grandmother's rate (0-10%).

    Any thoughts on this approach?

    It's good to have a general idea of what might work, but only an elder law attorney and tax CPA that you engage will be able to give you the specific fact, circumstance, and goal based answer.  Until you have those conversations, you'll just be operating with general advice, which may not be optimal.

    There's a host of items that need to be considered, some of which have been mentioned and some of which have not (like the 5 year lookback period for medicaid).

    I generally like a trust-partnership holding structure in these situations, but again, it depends on the goals that need to be met, and which scenario has the most acceptable pros and cons.

    I would look closer at an LP or FLP instead of an LLC. I would also not advise making your mother the manager and extracting a management fee.

    Another consideration is whether your grandmother has capacity to agree to all of this, or if a POA needs to be put in place.

    Best of luck.