Legal/Tax structure for rental income paying medical bills

[Zach Westerfield]

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?

[Long D.]

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