Life Estates and Medicaid, what you need to know
By Paul Lorrah
Recently, an individual contacted us [we'll call him Bill] in regards to a life estate between he and his father. The transfer was done 7 years ago by the advice of his then, elder-law attorney in hopes of keeping the house safe from Medicaid should Bill's father need to enter a nursing home.
About 6 months ago, Bill's father entered a nursing home. He qualified right away because he life estate was not counted as an asset for Medicaid purposes. Since Bill's father cannot return to the home, Bill contacted us asking if he can sell the home and if he did how this would affect his father’s Medicaid eligibility.
While creating a life-estate can be a good option in the right circumstances, it is almost never the best option.
What is a Life Estate?
A life estate is a form of joint ownership that allows one person to remain in a house until his or her death, when it passes to the other owner. The person holding the life estate -- the life tenant -- possesses the property during his or her life. The other owner -- the remainderman -- has a current ownership interest but cannot take possession until the death of the life estate holder. The life tenant has full control of the property during his or her lifetime and has the legal responsibility to maintain the property as well as the right to use it, rent it out, and make improvements to it. Neither party can sell the home without the others consent.
What are the benefits of a Life Estate?
- When the life tenant dies, the house will not go through probate, since at the life tenant's death the ownership will pass automatically to the holders of the remainder interest;
- Since the property is not included in the life tenant's probate estate, it can avoid Medicaid estate recovery in states that have not expanded the definition of estate recovery to include non-probate assets. Even if the state does place a lien on the property to recoup Medicaid costs, the lien will be for the value of the life estate, not the full value of the property;
- Once the 5 year look back period for Medicaid eligibility has expired, the life-estate has no value for Medicaid purposes.
What are the Negative effects of a Life Estate?
- Neither party can sell the home without the others consent;
- If the house is sold during the Medicaid recipients lifetime, they will be entitled to a sum of money equal to their life-estate interest, which will disqualify them from Medicaid if they are already receiving Medicaid benefits for their long term care;;
- Although the property will not be included in the probate estate, it will be included in the taxable estate
- Be aware that transferring your property and retaining a life estate can trigger a Medicaid ineligibility period if you apply for Medicaid within five years of the transfer;
What happens if Bill sells the home now?
If Bill cannot assume the full cost of maintaining the home [taxes, mortgage, insurance, utilities, repairs, etc.] and he were to sell the home now and the net proceeds from the sale is $300,000. Because Bill's father is 82 years old, his Life Estate Interest value is .40295% or $120,000. Bill and his father live in Pennsylvania and based on Bill's father's income, he cannot keep more that $2,400 in assets and be eligible for Medicaid benefits. Therefore, if Bill were to sell the home, Bill's father would be disqualified from receiving his Medicaid benefits until he "spent down" the $120,00 he received from the sale of the home.
Which basically negates the reason for transferring the home to a Life Estate from the beginning.
Note that for Medicaid purposes, the sale of the home entitles Bill's father to the $120,000, so even if Bill didn't transfer the proceeds to his father, it would still count as an asset and disqualify him form Medicaid benefits.
And, as noted above, another important consideration when creating a life-estate is the capital gains tax implications. Since the property is not Bill's primary residence, he is not entitled to a capital gains exemption on his share of the proceeds, which means that if Bill sold the home now, he would be subject to capital gains taxes [the taxes would be based on the appreciation of the value of the home from the date Bill's father bought the property to the date of sale], which would reduce Bill's share of the proceeds by up to 25%
Is there a better alternative?
A much more preferable outcome could have been achieved by deeding the house to an Medicaid Asset Protection Trust. Using this trust and after Medicaid’s five year look-back had been achieved:
- The house would not be counted as an asset when applying for Medicaid;
- The house would avoid Medicaid's estate recovery;
- The house could be sold during the Medicaid recipient's lifetime without any of the proceeds counted as an asset by Medicaid;
- When the Medicaid recipient passes away the other party in the life estate would receive the property with a ‘stepped up basis,’ meaning no capital gains taxes would be due;
- The house could be sold during the Medicaid recipient's lifetime without incurring capital gains taxes.
What if we already have a Life Estate?
If you have a Life Estate and your aging parent is in need of care, one alternative that may be available is to rent the home and not sell until life tenant’s death. Under certain Medicaid rules, [rules vary by state, Medicaid has strict rules as to whether or not a rental house can be excluded as an asset when applying], you can use the rental income to pay the carrying charges on the premises. Any rental income in excess of the carrying charges will be considered income to the Medicaid recipient 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.
Medicaid planning is complex to say the least, do not attempt to put a plan or strategy in place without the aid of an experienced Medicaid expert. The results could be financially catastrophic.
Author Paul Lorrah is a Medicaid and Long Term Care Planning specialist who has authored such books as "Planning and Paying for Long Term Care' and "How to Get Medicaid to Pay for Your Long Term Care Costs".
If you have questions about the benefits and pitfalls of life-estates, irrevocable trust planning or asset protection, call Medicaid Plus, P.C for a free consultation today.