Estate Planning Isn’t Just For The Elderly

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Factors To Consider When transferring A Residence For Elder Law And Estate Planning Purposes: A Primer

By: Anthony J. Enea, Esq.

The decision to transfer one’s residence raises a number of significant and complex issues and concerns for both the attorney and client, for example; every potential transfer raises estate and gift tax, capital gains tax as well as Medicaid eligibility issues for the client, particularly a senior. A complete and thorough review of all available options should be made prior to making the transfer. The following is a review of the types of transfers of a residence that can be made and their consequences:

(a) Outright Transfer of the Residence 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 (original purchase price plus amount of any capital improvements made), and the outright transfer is a completed gift subject to gift taxes. Thus, a gift tax return will need to be filed and utilization of one’s lifetime gift and estate tax credit ($5.34 million per person for 2014) may need to be used. For Medicaid eligibility purposes, the outright transfer of the residence would be subject to a 60 month look back period (subject to exempt transfer rules). Thus, disqualifying the transferor and his or her spouse for nursing home Medicaid (not Medicaid homecare) for 60 months.

If Medicaid is needed within the 60 month look back period, the period of ineligibility on the transfer would not commence until the applicant was receiving institutional care (in a nursing home), had applied for Medicaid and would have been approved but for the transfer made.

Additionally, from a tax perspective the use of an outright transfer of the residence results in the transferor losing the Internal Revenue Code (“IRC”)’121(a) principal residence exclusion for capital gains (income tax) purposes of $250,000 (single person) or $500,000 (married couple). With the federal capital gains tax rate with the Medicare surtax being approximately 24%, the income tax impact could be significant. For some clients the combined state and federal income tax with the 3.8% Medicare surtax can exceed any applicable estate tax rates. Cost basis must be strongly considered before making an outright transfer of the residence. However, if after the transfer is made the transferee owns and resides in the premises for two out of the five years, he or she will be able to use said principal residence exclusion. Any Veteran’s, STAR and Senior Citizen’s Exemptions would also be lost with an outright transfer. It will also be necessary to obtain a fair market value appraisal of the premises gifted for purposes of calculating the federal gift tax credit utilized by the transfer. As can be seen from the above stated the consequences can be financially significant.

(b) Transfer of the Residence with the Reservation of a Life Estate

If the transfer was made within an existing Medicaid look back period (60 months), the period of ineligibility would not commence until the applicant was receiving institutional care in a nursing home and was otherwise eligible for Medicaid, but for the transfer made. Thus, a transfer of real property by deed with a retained life estate will also require that the transferor not apply for Medicaid within the look back period to avoid a significantly onerous period of ineligibility for nursing home Medicaid.

Pursuant to ‘ 2036(a) of the IRC, the transfer of a residence with a retained life estate permits the transferee of the residence to receive a full step up in his or her cost basis in the premises upon the death of the transferor, to its fair market value on the transferor’s date of death. This occurs because the residence is includible in the gross taxable estate of the transferor upon his or her demise. This, of course, presumes the existence of an estate tax upon the death of the transferor. A “life estate”, pursuant to IRC ‘ 2036(a), is the possession or enjoyment of, or a right to the income from the property or the right either alone or in conjunction with another to designate the persons who shall posses or enjoy the property or income thereof.

The most significant problem resulting from utilization of a 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) a loss of the step up in cost basis, thus, subjecting the transferee to a capital gains tax on the sale with respect to the value of the remainder interest being sold (difference between transferor’s original cost basis, including capital improvements, and the sale price), and (b) the life tenant pursuant to Medicaid rules 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 may be significant and will be considered an available resource for Medicaid eligibility purposes, thus, impacting the transferor’s eligibility for Medicaid. The existence of the possibility that the premises may be sold prior to the death of the transferor(s) poses a significant detrimental risk that needs to be explored in great detail with the client if a deed with the reservation of a life estate is contemplated.

It may be advisable to make the gift an “incomplete gift” for gift tax and capital gains tax purposes, the reservation of a limited testamentary power of appointment by the Grantor should be considered.

It should be remembered that IRC ‘2702 values the transfer of the remainder interest to a family member at it full value without any discount for the life estate retained. Retention of a life estate falls within one of the exceptions of
IRC ‘ 2702.

If the transfer does not fall within IRC ‘ 2702 or if one of the available exceptions applies (e.g. treated as a transfer in trust to or for the benefit of), calculation of the life estate is performed pursuant to IRC ‘ 7520, and the tables for the month in issue need to be consulted to determine the correct tax value of the remainder interest. For Medicaid eligibility purposes, the Social Security Life Expectancy table is used to value the life estate and remainder interest.

Pursuant to IRC ‘ 2702 if the homestead is transferred to a non-family member, the use of a traditional life estate will result in a completed gift of the remainder interest. It should also be remembered that the gift of a future interest (remainder or reversionary interest) is not subject to the annual exclusion of $14,000 per donee for the year 2014.

c) Transfer to a Medicaid Asset Protection Trust a/k/a an Irrevocable Income Only Trust.

From a purely Medicaid Planning perspective, the use of the Medicaid Asset Protection (MAP) in my opinion is the most logical option. As previously explained, irrespective of the fair market value of the residence transferred to the Trust, the period of ineligibility will effectively be five years (60 months). However, the properly drafted MAP will allow the residence to be sold during the lifetime of the transferor with little or no capital gains tax consequences, as the transferee can utilize the transferor’s personal residence exclusion of $500,000, if married, and $250,000 if single. This can be accomplished by reserving in the trust instrument the power to the Grantor(s) in a non-fiduciary capacity and without the approval and consent of a fiduciary to reacquire all or any part of the trust corpus by substituting property in the trust with property of equivalent value. The Grantor(s) will be considered the owner of the trust corpus for income tax purposes. See IRC ‘ 675(4). 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, through the reservation of a life income interest (life estate) to the Grantor. IRC ‘ 2036(a).

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 the MAP an ideal option in most circumstances.

The transfer of the residence to the MAP is a taxable gift of a future interest, no annual exclusion available. Full value of premises reported on gift tax return.

If a limited power of appointment is retained, the gift to the trust is incomplete. Treasury Reg. 25.2511-2(b). No gift tax return is technically required, however, it is advisable to review with an accountant the filing of a gift tax return for informational purposes.

On the death of the Grantor of the Trust, the date of death value of all assets in the trust will be included in the Grantor’s taxable estate pursuant to ‘ 2036(a) of the IRC, as a result of the life income interest retained by the Grantor.

Inclusion in Grantor’s estate will result in a full step up in cost basis for all trust assets pursuant to ‘1014(e) of IRC, assuming an estate tax is still in existence at the time of the Grantor’s demise.

In conclusion, it is most important that all of the aforestated options and their consequences be thoroughly reviewed with the client prior to a transfer of real property being made. Just saying to the client lets do a quitclaim deed to your kids without a thorough explanation of the ramifications will inevitably lead to future problems.

Anthony J. Enea, Esq. is the managing member of the firm of Enea, Scanlan & Sirignano, LLP of White Plains, New York. His office is centrally located in White Plains and he has a home office in Somers, New York.
Mr. Enea is the Immediate Past Chair of the Elder Law Section of the New York State Bar Association.
Mr. Enea is a Past President and a Founding Member of the New York Chapter of the National Academy of Elder Law Attorneys (NAELA). He is also a member of the Council of Advanced Practitioners of NAELA.
Mr. Enea is a Past President of the Westchester County Bar Association.
Mr. Enea is a Vice President of the Westchester County Bar Foundation.
Mr. Enea is the Vice President of the Columbian Lawyers Association of Westchester County.
Mr. Enea focuses his practice on Elder Law, Wealth Preservation, Guardianships, Medicaid Planning and Applications, Wills Trusts and Estates.

Enea, Scanlan & Sirignano, LLP