Protecting The Home: Using Trusts To Protect Your Home From The Costs Of Long-Term Care – Begley Report
by: Begley Law Group
by Thomas D. Begley, Jr., Esquire, CELA
Studies show that 43% of Americans will spend some time in a nursing home. Seventy percent will require some form of long-term care be it nursing home, assisted living or home care. The cost of this care can range from $20 – $25 per hour or more for home care to $10,000 – $14,000 per month for nursing home care. Those with assets are expected to use those assets to pay for their own care, unless they have long-term care insurance. If a single person applies for Medicaid to pay for this care, the Medicaid agency will require that the home be sold and that the proceeds of sale be used to finance the care. If a Medicaid applicant is married and owns a home as tenants by the entireties with his or her spouse, then upon death of the Medicaid recipient a lien will be placed upon the home to repay Medicaid for the medical assistance paid on behalf of the deceased Medicaid recipient.
Most of us have worked hard and lived frugally and we want very much to protect our home, if we need long-term care in the future. Unfortunately, only 6% to 8% of people in the United States have long-term care insurance. The primary reason this figure is so low is that the cost of the insurance is high and most people simply cannot afford it. While the industry says that almost everyone can afford long-term care insurance, other studies show that if people pay their mortgage payments, pay toward college tuitions, and save for retirement, then they really cannot afford to pay the premiums for long-term care insurance policies. For a vast majority of people, Medicaid is the ultimate option.
How is it possible to protect the home and still qualify for Medicaid? The idea would be to transfer the home five years before applying for Medicaid, and therefore, the transfer would be beyond the Medicaid five-year lookback and would be protected. Unfortunately, we do not know when we will need Medicaid or whether we will have five years. However, if we transfer the home now and need long-term care in four years, it is only necessary to pay one year of care privately, if an individual would otherwise be eligible for Medicaid. The sooner the transfer is made, the more likely it is to succeed. Like most things in life, planning ahead is essential and timing is key.
Most people who transfer their home want to transfer it to their children, wait the five years, and then have the home protected from Medicaid. This is usually not a good idea for several reasons. These include:
♦ Risk factors. If a home is transferred to a child, the home could be lost, in whole or in part, if:
- the child has creditors who sue the child;
- the child winds up in a divorce;
- the child is on public benefits and the transfer may cause the child to lose those benefits; or
- the child dies and leaves the house to his or her spouse or children.
♦ Capital gains tax. There is a concept in the tax law known as carryover basis. If a parent paid $200,000 for a home many years ago and it is now worth$400,000 and the parent sells the home, the first $250,000 of profit is excluded from capital gains tax if the parent is single, and the first $500,000 is excluded if the parent is married. However, if the home is transferred to the child, that primary residence exclusion is lost because the child is not the owner and occupant of the home. The maximum federal capital gains tax rate is 20%. In addition, state income taxes must be considered, so let’s assume the combined federal and state tax rate is 25%. In our example, if the child sold the home, there would be a $200,000 gain and the children would have to pay $50,000 of capital gains tax.
♦ Step up in basis. On the other hand, if a parent dies and leaves a home to a child, the child’s cost basis is no longer the $200,000 that the parent paid for the home, but the value of the home on the parent’s death. Let’s suppose the home is still worth $400,000 on the parent’s death. Now the child’s basis would be $400,000 and if the child sells the home shortly thereafter, there would be no gain and no capital gains tax.
♦ State real estate tax benefits. In New Jersey there are a number of real estate tax benefits attendant to ownership of a primary residence. These include a homestead tax rebate, senior citizen’s deduction, veteran’s deduction, veteran’s exemption for disabled veterans, and a tax freeze. If the home is transferred to children and the children do not occupy the home, then all of these benefits are lost. Even if the child does occupy the home, if the parent was a veteran and the child is not, the veteran’s deduction would be lost. If the parent was eligible for a senior citizen’s deduction and the child is not, then that deduction would be lost. In addition, many parents itemize their deductions and include their real estate taxes in those deductions. This would no longer be possible.
♦ Control. If the child or child’s spouse is unscrupulous, the child or spouse could conceivably sell the house out from underneath the parent or mortgage the house to obtain funds for the child’s own benefit. The child’s spouse might be involved if the child dies before the parent and the spouse inherits what is really the parent’s home.
♦ Gift tax. In 2020, the maximum annual exclusion gift from a parent to one child is $15,000 per year. Since the value of the home would be worth more than $15,000, a gift tax return would have to be filed with the Internal Revenue Service. However, no gift tax is imposed until the total of all gifts during lifetime exceeds $11,580,000 per individual and $23,160,000 for a married couple.
A BETTER SOLUTION
Rather than transfer the home to a child or children, the home could be transferred to a grantor trust. There are a number of advantages to this strategy:
♦ Control. The deed transferring the home could reserve a right for the parent to use and occupy the property for the rest of the parent’s life. This means that no one could sell the property out from under the parent or even mortgage the property, because the parent would have to sign the deed or the mortgage. This is true because of the reserved right to use and occupy in the deed. In addition, the parent would be responsible for the payment of the taxes and utilities, and would continue to receive the tax bill, the utility bills, and the parent would also be responsible for maintenance in connection with the property. This makes things very simple from an administration standpoint.
♦ Principal residence exclusion. The trust can be designed so that the $250,000/$500,000 primary residence exclusion is maintained. Therefore, if the parent decides to sell the house during his or her lifetime, the $250,000 exclusion for an individual or the $500,000 exclusion for a married couple would still be available to reduce or eliminate any capital gains tax on the sale of the home.
♦ Step up in basis. If the home is not sold during the parent’s lifetime, then the children would receive a step up in basis on the parent’s death. The children’s cost basis would be the fair market value on the date of the parent’s death, so that if they later sold the property at that figure there would be no capital gain and no tax would be due. The trust would have to be designed to provide this feature.
♦ Real estate tax benefits. Because the parent reserves the right to use and occupy in the deed, the homestead tax rebate, veteran’s deduction, senior citizen’s deduction, estate tax freeze, and the ability to itemize deductions on income tax returns are all preserved.
♦ Gift tax. The trust could be designed as an Intentionally Defective Grantor Trust (IDGT), so that the give would be considered by the Internal Revenue Service to be an “incomplete gift” and no gift tax filing would be required. In addition, the trust protects the parents against risk factors.
♦ Risk factors. The trust also protects the parent against risk factors.
- Creditors. Let’s suppose the parent appoints his son as trustee of the children’s trust. The son then is sued and a very large judgment is recovered against him. The judgment does not affect the parent’s home, because the judgment is against the son individually. In the case of a trust, the son is simply serving as trustee and the creditor has no rights against the assets in the trust.
- Divorce. Let’s suppose the parent appoints his son as trustee and subsequently the son is divorced. Assets in the trust would not be subject to equitable distribution in the son’s divorce or would it be considered a factor in determining alimony and child support because, again, the son is simply acting in a fiduciary capacity with respect to serving as trustee.
- Public Benefits. If a child is on public benefits or anticipates receiving public benefits, a trust can be designed to protect the home and to guarantee that it will not be counted as a resource for the child’s public benefit purposes, including SSI or Medicaid.
- Death of Child. If a child dies, the home would not pass under the will of the child or by intestacy, but would be controlled by the terms of the trust.
Another strategy, in the case of a married couple, is to transfer the home to a grantor trust with the idea that the healthy spouse can later buy back the home without a Medicaid transfer of asset penalty. Let’s suppose the home is worth $400,000. To oversimplify, let’s suppose that the community spouse is entitled to retain $128,640 as his or her Community Spouse Resource Allowance (CSRA). Let’s suppose that the ill spouse has an IRA and other liquid assets totaling $528,640. At such time as the ill spouse applies for Medicaid, the healthy spouse can buy the home back from the trust. Assuming the home is still worth $400,000, the well spouse can pay $400,000 to the trust and transfer the home in exchange for the payment. The community spouse can retain the remaining $128,640. The trust would then deed the home to the well spouse. Since the well spouse is occupying the home as his or her principal residence, it is a non-countable asset. There would have been no transfer of assets, for Medicaid transfer of asset purposes, when the home was purchased from the trust and the liquid assets placed in the trust, because the well spouse received something of value in exchange for the liquid assets. This strategy enables the couple to maintain control over their liquid assets, particularly their retirement assets, for a longer period of time.
♦ Keeping the Home in the Bloodline. If the parent so desires, the trust can be designed as a Bloodline Trust to keep the home, and any other assets transferred to the trust, in trust indefinitely. The trust can be designed to protect the children from their own bad decisions or from bad decisions made by dominating or abusive spouses.
HOW DO I ESTABLISH A TRUST?
The trust is simply a document that spells out the intention of the grantor. In this case, the grantor would be the parent or parents. Generally speaking, the trust document would provide that on the death of the surviving parent the children would be the beneficiaries of the trust and would receive the trust assets, including the home. The children do not have to be named beneficiaries, if the parent does not want this result. The trust does not have a Taxpayer Identification Number, because the parent’s Social Security Number is used. As long as the trust only owns the home, there is no taxable income and no tax return need be filed. The process is so simple that many clients establish the trust and deed the home into the trust and forget they have even done it.
Transfer of home to a children’s trust should be part of an overall plan. Begley Law Group (BLG) should review with the client, the client’s existing wills, living wills, and powers of attorney. The existing documents may be adequate, in which case no changes need be made. If changes should be made, these would be indicated by BLG and the client is free to make them or not. BLG prepares the trust, prepares the new deed, and has the trust and the deed property executed, witnessed, acknowledged, and recorded in the county recording office. BLG also assists in changing the ownership on the homeowner’s policy, and flood insurance if applicable, to reflect ownership by the trust. BLG then prepares a letter memorializing the transaction and explains to the client the effect of the transaction on Medicaid eligibility and real estate benefits as well as federal and state income tax benefits.
|Transfer of Home|
|Primary Residence Exclusion $250,000 – $500,000||Lost||Retained|
|Step-Up in Basis||No||Yes|
|Real Estate Tax Benefits||Lost||Retained|
|Children’s Public Benefits||Lost||Retained, if designed as SNT|
|Capital Gains Tax||Increased||Reduced or Eliminated|
|Gift Tax||Applies||Not Applicable|