In certain situations transferring a residence with the retention by the owner of a life estate is a common technique. The life estate provides the transferor with a level of comfort in knowing that their legal right to remain in the property for life is reserved in the deed, and that the life estate cannot be extinguished by a future sale, unless consented to. The retention of a life estate has advantages in terms of the transfer penalty period calculation if nursinghome care is required, as explained below. However, once the life estate is in place, the house will not likely be able to be refinanced or mortgaged.
When a home is transferred with a retained life estate, the person making the transfer retains the right to live in the home during his or her lifetime. He or she continues to pay the taxes and maintain the property. Any tax exemptions thus remain with him or her as the life tenant. As the life tenant retains these controls during his or her lifetime, the Medicaid program recognizes that the persons to whom the home has been gifted will not receive the full value of the home until the life tenant’s demise. Hence, the transfer of the home for Medicaid purposes is reduced by a percentage based upon the age of a life tenant since the retention of a life estate has a value which is retained by the transferor and therefore reduces the value of the residence transferred. The younger the life tenant, the less he or she has transferred. For example, at age 75, for Medicaid purposes, only fifty (50%) percent of the home has been transferred to incur an ineligibility period. For example, if a 75 year old Medicaid applicant transfers a home, the actuarial table used by the government determines that the penalty period should be applied to only fifty (50%) percent of the value of the home. Thus, a $400,000 home would be subjected to a penalty period as if only $200,000 were transferred. When divided by the assumed average cost of a nursing home in Nassau County of $10,555, the transfer of a home worth $400,000 will be subject to an ineligibility period of only twenty (20) months. This twenty (20) month period is calculated by dividing $200,000 by $10,555. After twenty (20) months, the entire house will no longer be considered an available resource when a Medicaid application is sought. After 2010, it is not certain that a home transferred with a retained life estate will receive a step up in tax basis.
Not only does the life estate reduce the penalty period for nursing home care even though it is an asset retained by the Medicaid recipient, Medicaid cannot presently recover against the Medicaid recipient's estate to recoup the value of the life interest retained.
Prior to 1993, it was the general rule that only the probate estate was subject to an estate claim against Medicaid. The probate estate is the portion of a decedent’s assets that passes under a Will, or by administration if there is no Will. OBRA, 1993, confirmed New York law by providing a definition of the term “estate” for recovery purposes. Estate was defined as all real and personal property and other assets included within the individual’s estate, as defined for purposes of state probate law. Since 1994, New York State has considered amending its statutes to broaden the definition of an estate for Medicaid recovery purposes, but has not yet done so. The proposed expanded definition included many assets that are not part of a probate estate, such as jointly owned property, life estates, etc. As of this time, only the probate estate is subject to a lien by Medicaid in the State of New York; and life estates for personal residences are not subject to such a lien.
Life Estate Advantages:
- Removes remainder interest in the house from Medicaid estate after five (5) years of transfer.
- Medicaid will only count the value of the remainder interest, which is a significantly lower value than the whole. This technique is commonly used to reduce the transfer value of a personal residence for Medicaid purposes and is backed by the courts. However, since the values of your other resources are significant, there will be no reduction in the overall penalty period.
- Original owner still maintains full control of property and its management and retains Veterans and STAR tax exemptions.
- Your income tax cost basis does not carry over to the children as long as property is held until death of original owner. Full value is included in original owner’s estate for tax purposes, but children still receive a full basis step up to fair market value upon death. Little or no capital gains tax would be incurred upon sale if the property is sold soon after death. However, based on recent changes to the tax law, should you die in the year 2010 (the year of total Estate Tax repeal), a capital gains tax could be imposed. However, this tax law change for 2010 as it applies to life estates, has not yet been clarified by the IRS.
Disadvantages of Life Estate:
- You must wait five (5) years from the date of transfer in order ensure that the entire interest is not available for Medicaid attachment.
- Difficult to sell the property until after the death of original owner unless all parties agree; However, if the property is sold by merging the interests, the cash from the sale of the life estate portion is attachable by Medicaid and the capital gains tax will be incurred by children.
- If you go into a nursing home before the five-year waiting period is up and do not return home, Medicaid could deem the life estate void for purposes of the reduced waiting period. (not an issue in your case)
- If you sell the house while receiving Medicaid, the actuarial value of your life estate will be an available resource. It would be advisable to rent the property if the premises are vacated due to medical reasons; but the net rental income (property taxes and habitable repairs only are allowable expenses) would be considered available for the payment of your medical care, i.e., nursing home care.
A trust is a legal relationship in which the legal ownership of property is separate from the beneficial ownership. The trustee is responsible for holding and investing money or other assets (called the trust “principal” or “corpus”) for the current or future benefit of another person(s) called the “beneficiary(s)”.
The person who contributes the assets and creates the trust is called the “grantor” “settlor” or “trustor”, all of which have identical meaning. The terms and conditions of the trust as dictated by the grantor are stated in a written document called a trust agreement, also known as a “trust indenture” or “deed of trust”. A trust agreement names the grantor, trustee and beneficiaries, describes how the assets of the trust are to be managed and invested, determines who is entitled to distributions of assets from the trust, what restrictions are placed upon distributions to beneficiaries, what ages or under what circumstances the beneficiaries will receive their shares and the purpose of the trust. Distributions of trust assets may also be split between income and principal and are useful in Medicaid planning.
Trusts can be revocable, irrevocable, inter vivos or testamentary. A revocable trust can be amended or terminated at any time by the grantor. It's most common purpose is to avoid probate upon the death of the grantor but does not help save or reduce estate taxes or protect assets from Medicaid.
An irrevocable trust is used primarily to transfer assets to children or grandchildren with the intent of saving taxes or protect assets from the costs of long term care. Once created, the terms and conditions of an irrevocable trust cannot be changed, and the transfer of assets to that trust cannot be reversed unless special powers of appointment are included.
An inter-vivos or “living trust” is created and funded while the grantor is alive. In contrast, a testamentary trust takes effect upon death of the grantor and its terms are stated in a Will, as opposed to in a separate agreement.
A trust can provide the following estate preservation goals:
- providing a trustee for investment and asset management;
- ensuring that assets go to the right people, at the right times, for the right purposes, and in the right amounts without court intervention;
- protecting assets from depletion as a result of long term care costs by starting the 5-year look back period for Medicaid;
- where possible, obtaining a step-up in cost basis at death for assets with a low cost basis
Irrevocable Income Only Trust
A funded Irrevocable Income Only Trust can be used to provide for asset protection, as well as asset management and financial decision making. Unlike a revocable trust, the trust assets will not be considered available for purposes of Medicaid eligibility after the penalty or look back period has elapsed.
When an individual transfers assets into an irrevocable trust, from which no principal may be accessed for the benefit of that individual, after the applicable waiting period caused by the transfer of assets, the funds in the trust will no longer be considered an available resource to pay for care by the Medicaid program. As per the discussion concerning the look back period, assets transferred into a trust are subject to a five (5) year look back period.
Trusts are often drafted to pay all income to the grantor/beneficiary. Distribution of Trust principal is often not prohibited when made to the remainder beneficiaries. Assets in a Trust are protected from creditors of the remainder beneficiaries. An individual’s primary residence is often used to fund an irrevocable trust for Medicaid purposes.
The benefits of creating these trusts are:
- Preserve the right to live in the home for life;
- Preserve the right to receive any rents or income generated by the trust assets for life;
- Preserve all senior and STAR property tax exemptions;
- Achieve a step-up in income tax basis at death; and
- Preserve the $250,000 exclusion on the sale of the principal residence, should the home be sold during your lifetimes.
Management of Assets and Income. The assets placed in trust would be managed by your trustee (i.e., your children) according to the trust provisions. You would be entitled to receive the income from the trust but you would not have direct access to the principal of the trust at any time. Further, you would retain a limited power of appointment, exercisable by you under your Will, so that you can alter the ultimate disposition of the trust assets, if you so desire. If you do not exercise this power, then upon your demise the trust assets would be distributed according to your desires stated in the trust. Under the Internal Revenue Code, certain retained powers also allow many of the stated income tax benefits to remain even though the house is owned by the trust.
Avoidance of Probate. The assets held in trust will not be subject to a probate proceeding. This step will potentially save legal fees and court filing fees for your family and avoids any unnecessary delay in the distribution of the trust assets.
Medicaid Eligibility. Once sixty (60) months (the 5-year look back period) has expired from the first day of the month after the date the assets are placed into the trust, then the trust assets would not be considered an available resource for purposes of Medicaid eligibility; but the income earned on the trust assets would be considered available for the payment of medical care, i.e., nursing home care.
Income Taxation. The trust income is taxed to you (the person who set up the trust) along with the right to take all deductions under the Grantor Trust rules of the Internal Revenue Code as if the trust never existed, but the trust is required to file an annual income tax return.
Gift and Estate Taxation. There would be no gift taxation upon the funding of the trust, because the special power of appointment renders the transfer an incomplete gift, even though a federal gift tax return must be filed. Upon your demise, the value of the trust would be included as part of your estate for estate tax purposes.