Estate Planning Isn’t Just For The Elderly

Happy, smiling couple in their sixties.

The Deficit Reduction Act Of 2005 and Its Effect Upon Transfers Of Real Property For Long Term Care Planning Purposes

By: Anthony J. Enea, Esq.*

On December 18, 2005, the U.S. Senate, in a vote of 51-50 with Vice-President Cheney casting the deciding vote, passed the Deficit Reduction Act of 2005 (“DRA”). As a result of some differences in the Senate and House versions, the legislation was sent back to the House of Representatives for a final vote. On February 1, 2006, the House of Representatives approved the DRA by a vote of 216 to 214. On February 8, 2006, President Bush signed the legislation into law. It will effect all non-exempt transfers of assets made on or after February 8, 2006. Pursuant to the DRA, the States have a specified period of time within which to adopt the provisions of the legislation or enact enabling legislation if determined to be necessary. It is anticipated that New York will adopt said changes effective retroactively to February 8, 2006.

The DRA affects Medicaid eligibility and the transfer of asset rules in three (3) significant ways:

1. Creation of a sixty (60) month look back period for all transfers of assets, irrespective of whether they are outright transfers or transfers to certain trusts. Under the prior law there was a sixty (60) month look back period for transfers to certain trusts (i.e., Irrevocable Income Only Trust) and a thirty-six (36) month look back for all other transfers. Thus,
under the DRA, an applicant for Medicaid will be required to inform Medicaid of all transfers made and provide financial documentation to Medicaid for the five (5) years preceding the date Medicaid is requested.

2. The penalty period (period of disqualification for Medicaid) created by a non-exempt transfer of assets will commence on the later of (a) the month following the month in which the transfer is made (as under prior law), or (b) the date on which an individual is both receiving institutional level of care (i.e., is in a nursing home or receiving care at home under the Lombardi program or other waivered program) and whose application for Medicaid would be approved, but for the imposition of a penalty period at that time.
Under the new legislation, therefore, the penalty period for a non-exempt transfer of assets made within the sixty (60) month look back period will commence when the applicant has $4,150 or less, is receiving institutional care (in a nursing home or under a waivered long term home health care program), has applied to Medicaid for assistance, and the application would be approved but for the penalty period imposed. This is the most onerous measure contained in the new legislation.

It should be noted that, pursuant to the provisions of the new DRA, and as under the prior law, no penalty period is imposed for transfers made by an applicant requesting non-waivered community Medicaid (homecare medicaid).

3. An applicant’s Homestead (house, condo, co-op) with equity above $500,000 will render an applicant ineligible for Medicaid. This provision does not apply if a spouse, child under age of 21, or a blind or disabled child resides in the house.

Each state, however, is given the ability to increase the amount of permitted home equity to an amount not in excess of $750,000. Additionally, homeowners will have the ability to reduce their equity through a reverse mortgage or home equity loan.

Some of the other significant changes contained in the DRA with respect to Medicaid are: (a) annuities will be required to name the state as a remainder beneficiary, and annuities that have a balloon payment will be considered a countable asset; (b) multiple transfers in more than one month must be aggregated; (c) the “income first” rule will be mandatory in all states (already required in New York); (d) penalty periods will be imposed for partial months (rounding down will no longer be permitted); (e) Partnership long term care insurance policies will be permitted in additional states other than the four presently permitted, which include New York.


Even before the enactment of the DRA the decision to transfer the primary residence raised a number of important issues and concerns for both the attorney and client (for example; gift taxes, potential capital gains tax consequences and, of course, the transfers impact on the Medicaid eligibility of the senior). However, once the decision is made to transfer the primary residence to someone other than a spouse, for Medicaid planning purposes, there are generally three primary planning options available:

(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/value upon receipt plus capital improvements), and
the outright transfer is a completed gift subject to gift taxes. For Medicaid eligibility purposes and pursuant to the DRA, the outright transfer of the residence would be subject to a 60 month lookback period, and if the transfer of the residence was made within the lookback period, the ineligibility period created would not commence until the individual enters the nursing home has applied for Medicaid, and would otherwise be eligible but for the transfer. Regardless of the value of the real property transferred, the DRA will effectively disqualify the individual from applying for Medicaid for 60 months.

For example, although the formula used to calculate the period of ineligibility created by a non-exempt transfer of assets is to take the fair market value of the property transferred and divide said amount by Medicaid Nursing Home Rate for County of Applicant’s Residence ($8,724 (Westchester County Rate), under the DRA, if the transfer was made within the 60 month lookback period, the period of ineligibility would not commence until the applicant is receiving institutional care (in a nursing home) or care under a waivered long term home health care program, has applied for Medicaid, and would be 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 of $250,000 (single person) or $500,000 (married couple). However, if the transferee owns and resides in the premises for two out of the five preceding years, he or she will be able to use said principal residence exclusion. Any Veteran’s, STAR and Senior Citizen’s Exemptions are also lost by an outright transfer. It is necessary to obtain a fair market value appraisal of the premises gifted for purposes of calculating the federal gift tax credit ($1,000,000 per person) utilized by the transfer.

(b) Transfer of the Residence with the Reservation of a Life Estate. Under prior law and from purely a Medicaid planning perspective relevant to the length of the ineligibility period created by a non-exempt transfer, this option had some important advantages. Because the retained life estate is given a value by Medicaid, which is subtracted from the overall fair market value of the premises at the time of transfer, the period of ineligibility for Medicaid could, depending on the age of the transferor, be significantly reduced. It was possible to create a period of ineligibility for Medicaid that was often less than 36 months. This was 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, wherein no reduction in the value of the fair market value of the assets transferred is permitted for purposes of calculating the period of ineligibility. However, the DRA has significantly reduced the effectiveness of this option. Although the period of ineligibility created by a deed with a reservation of a life estate would not be longer than 36 months, pursuant to the DRA, if the transfer was made within the lookback period (60 months), the period of ineligibility would not commence until the applicant is receiving institutional care in a nursing home or under a waivered long term home health care program (Lombardi program) and was otherwise eligible for Medicaid but for the transfer made (i.e. has no more than $4,150). Thus, under the new law a transfer of real property by deed with a retained life estate will also effectively create a five (5) year period of ineligibility.

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 §2036(a) of the IRC 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. (Sample language for a life estate is attached.)

The most significant problem in utilizing a deed with the reservation of a life estate results 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) pursuant to Medicaid rules 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 impacting the transferor’s eligibility for Medicaid or being an asset against which Medicaid may have a lien. 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 for tax planning purposes it is prudent to make the gift an “incomplete gift” for gift tax purposes, the reservation of a limited testamentary power of appointment to the Grantor should be considered. (Sample language for a limited testamentary power of appointment is attached.)

It should be remembered that §2702 of the IRC values the transfer of the remainder interest to a family member at its full value without any discount for the life estate retained.
Retention of a life estate falls within one of the exceptions of §2702. If the transfer does not fall within §2702 of the IRC, 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.

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 $12,000 per donee for the year 2006.

(c) Transfer to an Irrevocable Income Only Trust a/k/a (“Medicaid Qualifying Trust”). As a result of the enactment of the DRA, and from a purely Medicaid Planning perspective, the use of the Irrevocable Income Only Trust may be 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) in order to avoid the harsh penalties contained in the DRA for transfers made within the look back period. However, the properly drafted Irrevocable Income Only 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, 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 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.§2036(a) of the IRC.

While the lengthy Medicaid ineligibility period must be appropriately considered, 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 the Irrevocable Income Only Trust an ideal option in most circumstances.

The transfer of the residence to the Irrevocable Income Only Trust is a taxable gift of a future interest, no annual exclusion available. Full value of premises reported on gift tax return. If the value is over $1,000,000, gift taxes are due.

If a limited power of appointment is retained, the gift to the trust is incomplete (Treasury Reg. 25.2511-2(b) and no gift tax return is required.
As a result of the life income interest retained by the Grantor, 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. Inclusion in Grantor’s estate will result in a full step up in 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.


The new law more than anything else severely punishes those who procrastinate in planning for their long term care. Whether it be the transfer of assets to an Irrevocable Income Only Trust, use of a deed with a life estate or the purchase of long term care insurance, it is clear that through advance planning one can limit the extent of his or her exposure to the costs of long term care.


“Grantor reserves the power to appoint the remainder and/or Grantor’s life estate in the premises to any one or more of the issue of the Grantor, siblings of the Grantor, or issue of the Grantor’s siblings, or the spouses or surviving spouses of any of the foregoing persons, with the term “issue” being deemed to include persons who have been adopted according to law or born out of wedlock. This power shall be exercisable or may be relinquished during the Grantor’s lifetime by a deed executed to the Grantee(s) herein or to others who are members of the class of appointees set forth herein, making express reference to this power and recorded in the County Clerk’s Office where this deed is recorded, prior to the Grantor’s death. This power shall not be exercisable to a Will. No exercise of this power shall be deemed to release the Grantor’s life estate unless such a release is explicitly made in a deed. The exercise of this power shall exhaust it, and unless the power is specifically released in such a deed, the deed recorded last shall control as to any ambiguities or inconsistencies.

This power can not be exercised in favor of Grantor, Grantor’s estate or Creditors of Grantor.”

Release and termination of the limited power of appointment “completes” the gift and requires the filing of a gift tax return for the full fair market value of the property (sale price).


A SUBJECT TO AND RESERVING UNTO the party of the first part, ______________________ , an estate in and to said premises during her lifetime such that the party of the first part reserves the right to the use and possession of the premises during her lifetime. The party of the first part shall pay for all maintenance and repairs, water and sewer charges, insurance charges and taxes related to the premises. The party of the first part reserves any and all real estate tax exemptions available to her including, but not limited to the STAR, Senior Citizens or Veterans exemption.”

Enea, Scanlan & Sirignano, LLP