To Deed Or Not To Deed: Revisited

By Anthony J. Enea, Esq.

Approximately four years ago when I wrote the article entitled "To Deed or Not To Deed?", I was not yet fully convinced that the Irrevocable Income Only Trust was necessarily the best vehicle to utilize when attempting to protect one's residence from the cost of long term care. At that time, I believed that the utilization of a deed with the reservation of a life estate was as equally viable an option. However, over the course of the last four years I have come to the conclusion, for the reasons stated herein, that the Irrevocable Income Only Trust is in most cases the best option.

The decision to transfer the primary residence raises for the attorney and client, a number of concerns and issues, for example; gift taxes, potential capital gains tax consequences, cost basis issues and of course, the transfers impact on the Medicaid eligibility of the senior. However, once the client has made the decision to transfer the primary residence to someone other than his or her spouse, for Medicaid planning purposes, the attorney will essentially have three planning options available: (a) Transfer of the Residence Outright without the Reservation of a Life Estate - Perhaps the least desirable option available, as the transferee of the property will receive the transferor's original cost basis in the property and the outright transfer is a gift subject to gift taxes. For Medicaid eligibility purposes the outright transfer of the residence could, depending on its fair market value, create a period of ineligibility for Medicaid of 36 months. However, the period of ineligibility could be less than 36 months depending on the residence's fair market value.

(b) Transfer of the Residence with the Reservation of a Life Estate - From purely the Medicaid Planning perspective, and the length of the ineligibility period for Medicaid created, this option has some important advantages. Because the retained life estate is given a value by Medicaid (consult HCFA tables), which is subtracted from the overall fair market value of the premises, the period of ineligibility for Medicaid is reduced. Depending on the fair market value of the premises it is possible to create a period of ineligibility for Medicaid that is less than 36 months. This is a distinct advantage over the use of a deed without the reservation of a life estate, and a transfer to an Irrevocable Income Only Trust which provides for no such reduction in the value of the fair market value of the assets transferred.

The transfer of the residence with the retained life estate also permits the transferee of the residence to receive a stepped up cost basis in the premises upon the death of the transferor, to its fair market value on the transferor's date of death, because the residence is includible in the gross taxable estate of the transferor upon his or her demise (see Section 2036(a) of the Internal Revenue Code). This, of course, presumes the existence of an estate tax upon the death of the transferor.

The most significant problem in utilizing the deed with the reservation of a life estate occurs if the premises are sold during the lifetime of the transferor. A sale during the transferor's lifetime will result in a loss of the step up in cost basis, thus, subjecting the transferee to a capital gains tax on the sale (difference between transferor's original cost basis, including capital improvements, and the sales price). Additionally, the life tenant is entitled to a portion of the proceeds of sale based on the value of his or her life estate. This portion of the proceeds could be significant and will be considered an available resource for Medicaid eligibility purposes, thus, potentially impacting the transferor's eligibility for Medicaid. The possibility that the premises could be sold prior to the death of the transferor(s) poses a significant detrimental risk that needs to be explained to the client.

If for tax planning purposes it is prudent to make the gift and "incomplete gift" for gift tax purposes, the reservation of a limited testamentary power of appointment to the Grantor should be considered.

(c) Transfer to an Irrevocable Income Only Trust - From the Medicaid Planning perspective the use of the Trust will generally create the longest period of ineligibility for Medicaid. Depending on the fair market value of the residence transferred to the Trust, the period of ineligibility could be five years. However, a properly drafted Irrevocable Trust will allow the residence to be sold during the lifetime of the transferor with little or no capital gains tax consequences, as it is possible to utilize the transferor's personal residence exclusion of up to $500,000 if married and $250,000 if single. Additionally, the transfer to the Trust can be structured to allow the transferee to receive the premises with a stepped up cost basis upon the death of the transferor.

While the potentially lengthy Medicaid ineligibility period is a pause for concern, however, the tax advantages and the continued flexibility of being able to sell the premises during the transferor's lifetime without income tax consequences, in my opinion, makes it an ideal option in most circumstances.

In conclusion, the best decision will only be made once a complete and thorough analysis of the transferor's health, family circumstances and all legal and tax consequences is made by the attorney.