Our answer wasn’t exactly what he wanted to hear, but it serves as a good lesson for anyone considering using a life estate as an asset protection tool. While creating a life-estate can be a good option in the right circumstances, it is almost never the best option.
When you create a life-estate you are essentially splitting the ownership of the home into two: the present interest [in this case Mom] and the future interest [the son]. This restricts either party’s ability to sell the house without the other party’s consent. It also means that as long as the house is not sold during the mother’s life her life-estate has no value for Medicaid purposes. However, once the house is sold she will be entitled to a sum of money equal to her life-estate interest. For example, according to the Social Security Life Expectancy Table for an 86 year old female, her life-estate interest in the home is equal to approximately 33%.
Assume the son sold the home and that the net proceeds from the sale was $330,000.00. One third of the net proceeds [$110,000.00] will be payable to his mother for her life estate interest. Because Medicaid asset guidelines allow a person to have only a restricted amount of assets in their name [the amount varies by state], once the house is sold and she received $110,000.00 she will no longer be eligible for Medicaid and will have to pay privately for her care until her assets are back down to her states max. amount. In this scenario a substantial portion of the house sale proceeds would be taken to pay for nursing home care.
It is important to note that were his mother to decide not to accept the proceeds of the sale of the home, it will still be considered a transfer of the full value and be treated no differently than had she taken the money resulting in a penalty being assessed despite her never receiving the money.
Another important consideration when creating a life-estate is the capital gains tax implications. Since the property is not the son’s primary residence he is not entitled to a capital gains exemption on his share of the proceeds. Accordingly, capital gains taxes will have to be paid on any appreciation from the date his mother bought the property to the day of sale, reducing his share by approximately 25%. His mother could apply her $250,000.00 capital gains exemption to her share of the proceeds since she lived at the premises at least two of the last five years and no capital gains tax will be due on her share of the proceeds. If you have a life estate, it’s best to not sell the home until the death of the life tenant.
Also, if the transfer of the home to a life estate is not done at least 60 months prior to the individual entering a nursing home, the transfer makes them ineligible for Medicaid due to their stringent transfer rules.
Another drawback is that it may subject the home to creditors, divorces, death and bankruptcy.
A much more preferable outcome could have been achieved by deeding the house to an irrevocable trust. Using an irrevocable trust, the mother would retain the right to sell the house and purchase a new property without involving her son. After Medicaid’s five year look-back had been achieved, the house would not be countable as an asset and when the mother passed away the son would have received the property with a ‘stepped up basis,’ meaning no capital gains taxes would have been due. [again, this must be done at least 60 months prior to needing a nursing home].
One alternative available to current life-estate holders is to rent the home and not sell until the life tenant’s death. Under Medicaid rules, you can use the rental income to pay the carrying charges on the premises. These expenses include but are not limited to: real estate taxes, homeowners insurance, utilities, landscaping, maintenance and repairs. Any rental income in excess of the carrying charges will be considered income to the Medicaid recipient in the month received and will have to be paid to the nursing home. This may enable you to hold onto the house and avoid losing a substantial portion of the proceeds to nursing home charges and capital gains taxes, however, putting the right plan in place from the beginning offers the most flexibility and protection and is obviously preferred.
Note: the above information is to be used at least 60 months prior to an individual needing nursing home care. If you feel you will need a nursing home prior to the 60 month financial “look-back” period Medicaid rules require, other strategies are available and will be necessary to save your home. If you have questions regarding Medicaid planning for a loved one, contact our office. PH: 855.471.6771 Email: firstname.lastname@example.org