Consequences of Continuing-Care Retirement Community Fees
By Sarah L. Mayes and Linda L. Nelms
MAY 2007 - Increasing
evidence shows that baby boomers are more willing to plan for their
long-term care than their parents were. They expect a postretirement
period well in excess of what previous generations expected, due
in part to increased life expectancy and to early-retirement options.
Many are less concerned about leaving an estate and more concerned
about supporting themselves throughout an extended period of retirement.
they are likely to consider include a continuing-care retirement
community (CCRC), a facility that provides residents with housing
and services that serve them from independent living through end
of life. Residents sign a detailed contract that allows for changing
needs and, as a result, different levels of services and housing
over time. The typical CCRC has three distinct levels: independent
living, assisted living, and skilled care. Independent living
is for residents who can see to their own needs and enjoy the
amenities of the facility. Assisted living provides residents
with support for the activities of daily living based on their
individual needs. Skilled care provides assistance for residents
who need skilled nursing services.
CCRCs provide residents with increasing levels of services as
their need for care increases, there are roughly three types of
CCRCs, categorized mainly by the amount of healthcare covered
in the agreement and how and when the resident pays for the healthcare.
Categories include Type A (extensive contract), Type B (modified
contract), and Types C and D (fee-for-service contracts). The
cash outflows associated with these options are entrance fees
and monthly fees. The category of the facility affects the tax
consequences for an individual.
A: Extensive Agreements
In an extensive,
also called a Type A, full-risk, or life-care agreement, an individual
pays a sizable entrance fee and monthly fees for the length of
tenure at the facility. The monthly fee will increase based on
operating expenses incurred by the CCRC but will not increase
based on a change in level of services provided. A portion of
the entrance fee and the monthly fees in this kind of facility
include payment for prepaid healthcare, which qualifies as a medical
deduction under IRC section 213.
of the deductible can be calculated by two methods: the percentage
method or the actuarial method. The IRS has always supported an
actuarial calculation based on healthcare utilization and longevity.
As an alternative, the percentage method calculates the facility’s
medical expenses as a percentage of total expenses. The Tax Court
in D.L. Baker v. Comm’r [122 TC 143, Dec. 55, 548
(2004)] upheld the use of the percentage method calculated on
an allocation percentage based on the number of community residents
and the weighted-average monthly service fees. The CCRC is responsible
for determining the amount of the entrance fee and the monthly
fee that should be allocated to prepaid healthcare and is, therefore,
deductible. Taxpayers and their advisors should know when considering
a Type A facility that the taxpayer is entitled to this deduction
and that the facility should provide the information annually.
can suggest the optimal time to pay the entrance fee. An individual
who has decided to enter a CCRC and has the flexibility to select
the date of entrance should consider in which year (or at what
time of year) the deduction for the prepaid healthcare will have
the most significant impact on tax savings. An individual who
enters a CCRC in January will accumulate more monthly healthcare
deductions than one who enters later in the year. An additional
tax planning opportunity exists to time other elective itemized
deductions, such as charitable donations and other medical expenses.
Taxpayers and their advisors must also consider the potential
impact of alternative minimum tax on these deductions.
amount of the monthly fee does not increase when the resident
of a Type A facility enters the assisted-living or the skilled-care
phase, the amount of the deduction increases because a larger
proportion of the monthly fee goes toward medically related expenses.
C and Type D: Fee-for-Service Agreements
On the other
end of the range of options, the fee-for-service arrangement may
have no healthcare prepayments. In the Type C facility, there
is an entrance fee and there are monthly fees in independent living,
but they may not include an element of prepaid healthcare, so
there would be no deduction associated with either the entrance
fee or the monthly fees. The Type D contract does not have an
entrance fee at all. As a result of the decision in D.L. Baker
v. Comm’r, some Type C facilities are notifying their
residents of the possibility of a healthcare deduction. The facility
is using a percentage method to allocate a portion of the actual
healthcare expenses the CCRC has incurred, as compared to the
total expenses. They are providing that information to residents
as a possible medical deduction with no guarantee.
If the resident
moves to assisted living, the monthly fees are automatically increased,
and a move to skilled care results in still higher monthly fees.
The individual or advisor must determine what portion of assisted-living
cost increases is related to healthcare. Skilled-care services
are healthcare related and are tax deductible.
B: Modified Agreements
category between extensive contract and fee-for-service is called
a modified, Type B, or partial risk arrangement. The tax consequences
may be less clear than with either Type A or fee-for-service CCRCs.
Type B facilities may or may not recognize a healthcare component
in their entrance fee or monthly fees. The resident pays higher
monthly fees when more healthcare services are needed. Type B
CCRCs differ from fee-for-service facilities, however, because
their contracts carry some kind of financial benefit in terms
of assisted living or skilled care. For example, one Type B facility
might allow residents a specific number of days’ stay in
assisted living or skilled care before the monthly fee is increased.
Another facility might guarantee a discount from the market-driven
price for assisted living or skilled care.
at the facility can provide the information necessary to determine
what portion of fees, if any, are allocable to prepaid healthcare.
summarizes the differences among CCRCs.
is available, some Type A or Type B facilities will accept individuals
directly into assisted living or skilled care, rather than the
typical initial entry into an independent living arrangement.
The individual accepted under this direct admission process may
be required to pay an entrance fee. This entrance fee is nondeductible
if it is to admit the resident into assisted living, unless the
entrance fee covers future rights for medical care in skilled
direct admissions will pay a higher monthly fee than those who
have been life-care admissions to Type A facilities. A resident
who enters a modified agreement (Type B) facility as a direct
admission will pay more in monthly fees than a resident who enters
under an admission contract that offers the discounted skilled-care
services. The housing and medical costs associated with skilled
care will be tax deductible, however.
the deductibility of assisted-living monthly fees requires reference
to IRC section 7702B(c) and Notice 97-31, which define “chronically
ill.” This definition is crucial to the deductibility of
the monthly fees because certain tax deductions that exist if
the taxpayer enters assisted living as a chronically ill individual
do not exist if the taxpayer enters for basic custodial care.
To qualify as chronically ill, an individual must be certified
by a licensed healthcare provider as unable to perform (without
substantial assistance) at least two “activities of daily
living” (eating, toileting, transferring, bathing, dressing,
and continence) for at least 90 days due to a loss of functional
capacity, or must require substantial supervision for protection
due to severe cognitive impairment.
option on the CCRC menu is the equity model. Residents of this
kind of facility “buy” their original dwelling in
the CCRC. When they vacate it, the unit is available for a new
resident and the proceeds from the next resident’s deposit,
up to the amount of the “owner’s” original entrance
fee, revert to the resident or the resident’s heirs. Because
the entrance fee is basically a deposit on a unit, there is no
tax saving relating to healthcare. Taxpayers and advisors must
carefully examine the contract to determine if it has any potential
planning opportunities exist in timing the payment of the entrance
fees and the liquidation of investments. If an individual enters
the facility early in the year, the tax-deductible portion of
the entrance fee added to the monthly fees attributable to healthcare
may result in significant itemized deductions. The deductions
might reduce taxable income to a level that will result in the
taxpayer’s capital gains and qualifying dividends being
taxed at a rate of 5% rather than 15%.
L. Mayes, CPA, MBA, is a lecturer, and Linda
L. Nelms, CPA, CMA, MBA, is a professor, both in the
department of management and accountancy at the University of
North Carolina Asheville, Asheville, N.C.