Transfer of a Primary Residence: The Tax and Long-Term Care Consequences

Anthony J. Enea, Esq.
Published Date:
Aug 1, 2017

A senior citizen’s decision to transfer a primary residence raises a number of important issues for both the attorney and client—for example, gift taxes, potential capital gains tax consequences, and of course the transfer’s impact on the Medicaid eligibility of the senior. Once, however, the decision is made to transfer the primary residence to someone other than one’s spouse, there are generally three primary planning options available for Medicaid planning purposes:

(a) Outright Transfer of the Residence Without the Reservation of a Life Estate

This is perhaps the least desirable option available because the transferee of the property will receive the transferor’s original cost basis in the property (original purchase price plus capital improvements), less any depreciation. The outright transfer is also a completed gift subject to gift taxes. For Medicaid eligibility purposes and pursuant to the Deficit Reduction Act of 2005 (“DRA”), the outright transfer of the residence would be subject to a 60-month look-back period (ineligibility for nursing home Medicaid). If the transfer of the residence was made within a previously created look-back period, the ineligibility period would not commence until the individual was in the nursing home, had applied for Medicaid coverage, and would otherwise be eligible for Medicaid coverage but for the transfer. It is important to note that the transfer of asset rules (60-month look-back period) do not apply to Community Medicaid (Medicaid homecare). (See 42 USC 1396p(c)(1)(B)(i) and the New York Department of Health’s Administrative Directive.)

From a tax perspective, the use of an outright transfer of the residence also results in the transferor losing the principal residence exclusion for capital gains of $250,000 (single person) or $500,000 (married couple) under IRC section 121. On the other hand, if the transferee owns and resides in the premises for two out of the past five years, he or she will be able to use the principal residence exclusion. Any Veteran’s, STAR, and Senior Citizen’s Exemptions are also lost. It is necessary to obtain a fair market value appraisal of the premises gifted for purposes of calculating the federal gift tax credit ($5,490,000 per person) utilized by the transfer. (See 26 USC 2001 and 2501.)

(b) Transfer of the Residence with the Reservation of a Life Estate

If the transfer was made within the Medicaid look-back 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 nursing home coverage within the look-back period to avoid an onerous period of ineligibility.

 Pursuant to IRC section 2036(a), 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 section 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 property or income thereof.

The most significant problem in utilizing a deed with the reservation of a life estate arises if the premises are sold during the lifetime of the transferor. A sale during the transferor’s lifetime will result in (1) a loss of the step-up in cost basis, 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 (2) the entitlement of the life tenant, pursuant to Medicaid rules, 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 treated as 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 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, consider the reservation of a limited testamentary power of appointment to the grantor. A limited testamentary power of appointment essentially allows the transferor to retain the right to change his or her mind as to who the ultimate beneficiary of the remainder interest will be. (See IRC section 2041).

Remember that IRC section 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 section 2702. If the transfer does not fall within IRC section 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 section 7520. Consult the tables for the month in issue to determine the correct tax value of the remainder interest.

Pursuant to IRC section 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 $14,000 per donee for the year 2017.

(c) Transfer to an Irrevocable Medicaid Asset Protection Trust

From a purely Medicaid planning and income tax perspective, the use of the Irrevocable Medicaid Asset Protection 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). A properly drafted Irrevocable Medicaid Asset Trust, however, will allow the residence to be sold during the lifetime of the transferor with little or no capital gains tax consequences.

It is possible to utilize the transferor’s personal residence exclusion (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. (See IRC section 679.) The grantor(s) will be considered the owner for income tax purposes. The transfer to the trust can also 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 section 2036 (a).)

While the Medicaid ineligibility period must be appropriately considered, in my opinion, the ability to sell the premises during the transferor’s lifetime without income tax consequences makes the Irrevocable Medicaid Asset Protection Trust an ideal option in most circumstances.

The transfer of the residence to the trust is a taxable gift of a future interest, and no annual exclusion is available. The full value of the premises is reported on a gift tax return. If the value is over $5,490,000, gift taxes may be due.

If a limited power of appointment is retained, the gift to the trust is incomplete. (See Treasury Regulation section 25.2511-2(b).) No gift tax return is technically required.
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 IRC section 2036(a), 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 IRC section 1014(e), assuming an estate tax is still in existence at the time of the grantor’s demise.

More than anything else, the DRA severely punished 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 one can limit the extent of his or her exposure to the costs of long-term care through advance planning.

In conclusion, prior to transferring one’s primary residence, thoroughly review and consider all options. There is too much at stake to make a hasty decision.

Anthony_EneaAnthony J. Enea, Esq. is a member of the firm of Enea, Scanlan & Sirignano, LLP, of White Plains, New York. His office is centrally located in White Plains, and he has an office in Somers, New York. Mr. Enea is the past chair of the Elder Law Section of the New York State Bar Association and is the past president and a founding member of the New York Chapter of the National Academy of Elder Law Attorneys (NAELA). He is also a member of the Council of Advanced Practitioners of NAELA. Mr. Enea is the president of the Westchester County Bar Foundation and a past president of the Westchester County Bar Association.

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