The Decision to Transfer One’s Residence to Loved Ones or a Trust Requires Consideration of Many Factors

By:
Anthony J. Enea, Esq.
Published Date:
Sep 1, 2021

Clients regularly call and advise me that they have decided to take steps to protect their home and/or vacation home for long-term care purposes. However, the decision to do so raises a number of significant and complex issues and concerns for both the attorney and client; for example, every potential transfer creates 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 the tax and other consequences of doing so.

Outright transfer of the residence without the reservation of a life estate
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This is 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 less any depreciation), and the outright transfer is deemed a completed gift subject to gift taxes (if more than $15K per person). Thus, a gift tax return will need to be filed and utilization of one’s lifetime federal gift and estate tax exemption ($11.7 million per person for 2021) will need to be utilized.  For Medicaid eligibility purposes, the outright transfer of the residence would be subject to a 60 month look back period (unless it qualifies as an exempt transfer).  Thus, disqualifying the transferor and his or her spouse for nursing home Medicaid for 60 months (5 years) and, effective January 1, 2022, a 30-month period of ineligibility for Medicaid Homecare for transfers made after October 1, 2020.

If Medicaid is needed within the 60-month lookback 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 for Medicaid, 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") S'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 being as high as 23.8% with the Medicare surtax and New York being 6.85% or higher depending on adjusted gross income, the tax impact could be very significant.  Cost basis must be strongly considered before making an outright transfer of the residence and/or any vacation home.  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 S121(a) principal residence exclusion.  Any applicable 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 exemption utilized by the transfer.  As can be seen from the above stated, the consequences must be thoroughly reviewed.

Transfer of the residence with the reservation of a life estate. If the transfer was made within an existing Medicaid lookback 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 S'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 S'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 possess 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 actuarial value of the life estate. The life tenant may also utilize the personal residence exclusion with respect to the consideration received for the value of their life estate as actuarially determined. This portion of the proceeds could be significant and will be considered an available resource for Medicaid eligibility purposes, irrespective of whether or not the life tenant takes the amount of the proceeds they are entitled to, 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 power of appointment by the life tenant should be considered. The limited power of appointment grants to the life tenant the ability to change their mind as to whom the remainder interest in the premises will go to. It should be remembered that IRC S'2702 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 IRC S'2702.

If the transfer does not fall within IRC S'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 S'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 S'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 $15,000 per donee for the year 2021.

Transfer to an MAPT. From a purely Medicaid planning perspective, the use of the Medicaid Asset Protection Trust (MAPT) is the most logical option. As previously explained, irrespective of the fair market value of the residence transferred to the MAPT, the period of ineligibility will effectively be five years (60 months). However, the properly drafted MAPT 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 making the MAPT a “grantor trust” under the provisions of S’671-679 of the IRC. For example, if the MAPT reserves to the grantor the power in a nonfiduciary 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 S'675(4)]. Additionally, the transfer to the MAPT 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 [see IRC S'2036(a)].

The tax advantages and the continued flexibility of being able to sell the premises during the transferor's lifetime with potentially no income tax consequences, in my opinion, makes the MAPT an ideal option in most circumstances.

The transfer of the residence to the MAPT is a taxable gift of a future interest, no annual exclusion available. Full value of premises is reported on gift tax return. If a limited power of appointment is retained, the gift to the trust is incomplete [see 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 S'2036(a) of the IRC, as a result of the life income interest retained by the grantor. Inclusion in the grantor's estate will result in a full step up in cost basis for all trust assets pursuant to S'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. Proposing to the client to just deed the property to your loved one’s without a thorough explanation of the ramifications will inevitably lead to future problems.

 


Anthony J. Enea, Esq., is a member of Enea, Scanlan and Sirignano, LLP of White Plains and Somers, NY. He focuses his practice on elder law, wills, trusts and Estates. Mr. Enea is the Past Chair of Elder Law and Special Needs Section of the New York State Bar Association (NYSBA). He is the current Chair of the 50+ Section of the NYSBA. He is the Past President and Founding Member of the New York Chapter of the National Academy of Elder Law Attorneys (NAELA). He is the President of the Westchester County Bar Foundation and a Past President of the Westchester County Bar Association.

Mr. Enea can be reached at (914) 948-1500 or at a.enea@esslawfirm.com.

 
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