A common dilemma that our Fortune 500 clients run into is how to preserve their homes while also gaining Medicare eligibility. A transfer subject to a life estate may be used to preserve your home and facilitate your eligibility for Medicaid. With this planning tool, you transfer the "remainder interest" in your house to your children (or other beneficiaries), and keep a "life estate" for yourself. As a practical matter, you deed the house to the remainder beneficiaries and incorporate language in the deed to retain your life estate. The life estate gives you the legal right to live in the house for life. As the "life tenant," you keep the responsibility for paying all ordinary and necessary expenses for maintaining the property, including property taxes, insurance, utilities, and routine repairs. When you die, the home passes to the remainder beneficiaries outright.
The advantage of this arrangement is that you can eliminate much of the value of your home from your financial picture for Medicaid eligibility purposes, and shorten any period of ineligibility while maintaining your right to live in the house. This is a powerful retirement tool that has proven effective for many of our Fortune 500 clients.
How Does It Work?
Remainder Interest Not Countable As Available Asset for Medicaid Eligibility Purposes
To qualify for Medicaid, both your income and the value of your other assets must fall below certain limits (which vary from state to state). In determining your eligibility for Medicaid, a state may count only the income and resources legally available to you for paying your medical costs.
A transfer subject to life estate can help you qualify for Medicaid by making your remainder interest in your house unavailable to you (and, therefore, unavailable to the state) once any period of ineligibility ends. However, the life estate itself is counted as an available asset. Medicaid uses a "Life Estate and Remainder Table" that calculates the value of your life estate based on your life expectancy and the home value. Further, because you retain an interest in the home, any period of ineligibility will be shorter than if you had transferred the home entirely.
Caution: If you (or, if married, both you and your spouse) enter a nursing home, the life estate still gives you the right to live in the house for life. However, if you are unable to return home, the house could (and perhaps must) be rented, and the net rental income would be applied toward your nursing home bills.
Preserves Home for Your Beneficiaries
Of course, along with helping you qualify for Medicaid, a life estate may help you preserve the house for your beneficiaries. When you die, the home passes to the remainder beneficiaries outright; the house is not part of your probate estate, and states will generally not be able to go after the home under a theory of estate recovery. Many of our Fortune 500 clients have felt that this is desirable.
Caution: Some states have adopted an expanded definition of an estate that includes non-probate assets that you hold an interest in at death. These states place a lien on your house after your death to collect the value of your life estate as of the date of your death.
Shortens Any Period of Ineligibility
Although the residence transfer subject is a powerful tool for Fortune 500 employees and retirees, there is a period of ineligibility. A gift of the remainder interest in your home, like any transfer of assets for less than fair market value, can create a waiting period or period of ineligibility before you can qualify for Medicaid. When you apply for Medicaid, the state has the right to review or look back at your finances (and those of your spouse) for a period of months before the date you applied for assistance. For transfers made on or after February 8, 2006, the look-back period is 60 months. So, if you give away a house (or a remainder interest in the house) within 60 months of the date that you apply for Medicaid, you may be ineligible to qualify for Medicaid for a period of months, based on a formula set by the state. This formula may be explained as the value of the remainder interest (from the actuarial tables) divided by the average monthly cost of nursing homes in your locale, the quotient being the number of months for which you will be disqualified from applying for Medicaid benefits. Because only the value of the remainder interest is used in the calculation, any period of ineligibility will be shorter than if you had transferred the home entirely.
Preserves Your Right to Live In the Property for Life
Preserving their legal right to live in their home is hugely important for many Fortune 500 employees and retirees. If you gift your house to your children outright (without reserving a life estate), you lose the right to live in the home. Therefore, if your children get divorced or owe money to creditors, the house can be sold and you'll have no place to live. By reserving a life estate, on the other hand, you preserve your right to live in the house. Even if your child sells his or her remainder interest in the property, the buyer would have to wait until your death to take possession of the property.
When you die, the property passes automatically and outright to the remainder beneficiaries, thus avoiding the expense and delay associated with probate.
Preserves Assets for Your Loved Ones (In Some States)
After your death, many states seek reimbursement from your estate for Medicaid benefits it paid on your behalf. In some states, "estate" refers to your probate estate only. Since any assets given away pursuant to a life estate arrangement would be eliminated from your probate estate, these states would be unable to seek title to those assets subject to this arrangement. Consequently, the assets would be preserved for your loved ones. This eliminates a huge fear that many Fortune 500 employees and retirees have, the state taking assets that they want to be passed down.
Helps You Qualify for Medicaid
A transfer subject to a life estate helps you qualify for Medicaid by making your remainder interest in your house unavailable to you (and, therefore, to the state) for purposes of Medicaid eligibility once any period of ineligibility ends. Further, any period of ineligibility is shortened because the value of your retained interest is not included in the calculation.
Minimizes Gift Tax on the Transfer
If you deed your home and retain a life estate, you will have made a completed gift of the remainder interest. The value of the gift is the fair market value of the home at the time of the gift, minus the value of your life estate. However, you may not have to actually pay federal gift tax if it can be offset by your applicable exclusion amount.
Provides Your Children with a Stepped-Up Basis
Another important factor that is often important to Fortune 500 employees and retirees is the tax benefits transferring a residence to a life estate can bring to their beneficiaries down the line. For income tax purposes, your children (or whomever you name as the remainder beneficiaries) are treated as though they inherited your property. In other words, in determining their capital gain on a later sale of the property, your children get to use the fair market value of the property on your date of death as their basis. This basis is referred to as a stepped-up basis.
Example(s): Assume John paid $70,000 for his home 25 years ago. He reserved a life estate in the property and gave the remainder interest to his daughter, Mary. When John dies, the property is worth $250,000. If Mary sells the property for $250,000, there will be no capital gain, since Mary gets the "stepped-up" basis of $250,000. If, however, John had simply given the house to Mary without reserving a life estate, Mary's basis would be $70,000. She would recognize a capital gain of $180,000.
Loss of Control Over Asset
Your gift of the remainder interest is irrevocable. This means that once you've transferred the property, legally speaking, you have no further control over its final disposition.
Value of Life Estate May Be Subject to Medicaid Estate Recovery in Some States
Your state can seek reimbursement from your estate after you die. For Medicaid purposes, the word "estate" has traditionally been construed by most states as your probate estate; that is, it has been interpreted by most states as being limited to those assets that pass under your will and has not been interpreted as including those assets that pass by beneficiary designation, or those that pass by operation of law. Some states have, however, adopted an expanded definition of estate to include all non-probate assets as well. Those states may exercise their ability to collect the value of your life estate at the moment before your death.
Sale of the Home During Your Lifetime May Be Problematic
Your percentage of the sale proceeds can be considered an "available resource" for Medicaid eligibility purposes and may disqualify you from receiving benefits.
How to Do It
Gather Your Medicaid Eligibility Information Before Consulting An Attorney or Other Financial Professional
- Prepare a list of all your assets (and those of your spouse), indicating how title is held, the tax basis, and how much you paid for the asset.
- Prepare a list of your (and your spouse's) income from all sources.
- Indicate whether your resources are, for Medicaid purposes, exempt, nonexempt, or inaccessible.
- Prepare a list of all assets transferred within the last 60 months, by way of gift, trust, life estate, or otherwise. Indicate date of transfer, transferee, purpose, and consideration (what you received in return).
Consult a Medicaid Law Attorney
Many Fortune 500 employees and retirees find Medicaid laws difficult to understand on their own. In recent years, Medicaid laws have undergone a number of changes. Indeed, because certain planning vehicles have been eliminated and most rules tightened, it is reasonable to expect that further changes will occur in the years ahead. It is vital, therefore, to consult with an attorney experienced with Medicaid planning. An attorney will advise you of your options, make recommendations, and ensure that establishing a life estate would be in your best interest.
Generally, there should be no income tax consequences of transferring your residence subject to a life estate. However, if the property generates rental income (e.g., a two-family house), the life tenant will continue to be responsible for reporting the rental income and expenses on Schedule E of his or her federal income tax return.
If you deed your home and retain a life estate, you will have made a completed gift of the remainder interest. The value of the gift would be the fair market value (FMV) of the home at the time of the gift, minus the value of your life estate. However, you may not have to pay federal gift tax because of the applicable exclusion amount.
If you have a life estate, the full FMV of the residence will be included in your gross estate for estate tax purposes.
Questions & Answers
When A Person Has A Life Estate In A Property, How Is His or Her Share of Proceeds Calculated When The Property Is Sold During His or Her Life?
If you hold a life estate in real property and sell the property during your lifetime, you're entitled to a share of the proceeds equal to the proportionate value of the life estate.
Example(s): Suppose a 60-year-old woman transferred her home to her son three years ago, subject to a life estate. She's decided to move in with her son and they both want to sell the house. She bought the home for $60,000 many years ago, and they have a buyer who'll pay $200,000 for it. Assuming the value of her life estate is about 74 percent and the value of her son's remainder interest is 26 percent, the woman's portion of the proceeds would be 74 percent of $200,000, or $148,000. Her son's portion would amount to 26 percent of $200,000, or $52,000.
In general, if you sell your principal residence at a gain, you may be able to exclude from taxation all or part of the capital gain. If you meet the requirements, you can exclude up to $250,000 (up to $500,000 for married couples filing jointly) of the capital gain, regardless of your age. You can generally exclude the gain only if you owned and used the home as your principal residence for a total of two out of the five years before the sale (the two years do not have to be consecutive). An individual, or either spouse in a married couple, can generally use this exemption only once every two years. However, a partial exemption may be possible even if you don't meet these tests.
Special capital gain exclusion rules apply when you sell a partial interest in your principal residence (such as a life estate). Assuming all requirements are met, you may exclude gain from the sale or exchange of a partial interest in your principal residence if the interest sold or exchanged includes an interest in the dwelling unit. However, only one maximum limitation amount of $250,000 ($500,000 for certain joint returns) applies to the combined sales or exchanges of partial interests. In other words, sales or exchanges of partial interests in the same principal residence are treated as one sale or exchange. See IRS Publication 523, Selling Your Home.
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