For many individuals, their most valuable asset is their home, and ensuring that its value passes on to their children upon their passing is of utmost importance. However, you are also concerned about planning for the future, declining health, and the potential need for expensive long-term care. You have heard that Medicaid can pay for that, but the rules say you can own no more than around $2,000 in assets to be eligible. Now what?
Medicaid Planning Using an Irrevocable Trust
One solution is to take that significant asset, your home, out of your name, while reserving your right to live in it. This can be done with a carefully drafted irrevocable trust. Putting the house in the ownership of a trust could prevent Medicaid penalties and ensure reimbursement of health expenses, depending on your state’s current rules. It all depends on whether your health continues to keep you out of care for the next five consecutive years.
There are numerous other advantages to that kind of trust, one of which is to avoid probate proceedings. Trusts are private agreements that usually require no court supervision. So, signing away valuable property can feel like a big step, but it keeps your living situation unchanged and can really pay off in the long run.
Avoiding Capital Gains Taxes
But suppose, later, you decide to sell the house and move into a smaller place. That could pose a capital-gains tax problem. If the trust hasn’t been carefully drafted, and it (not you) sells the home, the personal-residence exemption would be lost. Capital gains tax could be prohibitive if the house appreciated in value since the date of purchase.
A similar problem arises when it comes time for your children to inherit. If the trust is not carefully drafted to cover this eventuality, your heirs will lose the basis-adjustment tax break. That, too, could cost them dearly. The basis adjustment allows the inherited value of the home, for capital-gains purposes, to be calculated not from the date you originally purchased the home, but from the date your heirs inherit the property.
For example, suppose you paid $100,000 for your house in 1980 and you kept it in good condition. On your passing, the house is worth $300,000. Now suppose the home is titled in the trust name, but the trust wasn’t written carefully to preserve the basis adjustment that would otherwise be allowed for inherited property. If the children sell the home for $350,000 in those circumstances, they would have made a taxable profit of around $250,000.
With the basis adjustment, however, profit would be calculated from the $300,000 mark as of the date of inheritance. This would leave your children with a tax bill on the $50,000 profit, not $250,000. This tax advantage comes from “stepping up” the taxable basis to the market price at the time of inheritance. As a result, your family receives more value by having to pay less taxes.
Protecting Your Assets for Heirs with an Irrevocable Trust
First, the irrevocable trust takes the home out of your name and, instead, titles it to the trust. Medicaid rules view the owner of the property as the trust, not you, and that’s what you want to reduce your assets and qualify for Medicaid assistance.
Next, to preserve the personal residence capital-gains exemption, an irrevocable trust creates what’s known as “grantor trust” tax rules. Current tax rules allow property owned by this kind of trust to remain part of your estate for tax purposes, and exempt from capital gains up to specified value limits, depending on your state and whether you file single or jointly as a married couple.
Even though the trust has ownership, you are still allowed to take the personal-residence exemption. For capital gains, the IRS disregards the trust.
Then, to minimize your heirs’ exposure to capital gains tax in the future, the trust also provides a “limited testamentary power of appointment.” The appointment power permits you to designate someone with the authority to disburse your assets to chosen beneficiaries, provided those beneficiaries are limited to family or charities.
The limited power of appointment allows your assets to pass down to beneficiaries while preserving eligibility for both the tax basis adjustment and Medicaid.
The right estate planning strategies neatly solve Medicaid planning and tax issues by:
- Transferring the house title to the irrevocable trust while retaining your right to live in it, avoiding Medicaid penalties or reimbursement problems after five years,
- Creating grantor trust status to preserve the residence exemption, avoiding capital gains tax on the sale during your lifetime, and
- On your death, the adjusted-basis tax break is preserved by designating a person or entity to administer the assets in the trust.
Trusts are carefully drafted to comply with current rules regarding ownership and taxes to prepare for Medicaid eligibility and protect your assets for your family.
You may have a will, but it will not be able to protect your assets unless it becomes part of an estate plan that include an irrevocable trust. Bring us your will or estate plan, and let us look it over. If we find that it isn’t Medicaid-qualified, or it lacks provisions for grantor trust or the necessary powers of attorney, don’t worry. An irrevocable trust can be changed. Trusts that fail to account for various contingencies can happen if you don’t know where to find a trusted and reputable estate planning attorney. Many states have passed legislation permitting the modification of trusts for tax reasons, even if the trusts are nominally irrevocable. All parties must consent, or court proceedings would be required, but an expert Estate Planning or Medicaid Planning Attorney knows how to correct these problems efficiently.
Contact our office at (718) 979-7477 to set up a time to discuss planning opportunities.