The challenges begin when homeowners don’t do any Medicaid planning and decide the best answer is simply to gift their home to their children. It doesn’t always work out well for the homeowners or their children, warns the article “Owning real estate without jeopardizing Medicaid paying for nursing home” from limaohio.com. This issue requires the consideration and balancing of capital gains taxes, receipt of countable assets from the sale of the home, and the Medicaid lien recovery rules. Optimallly, you want to find a solution that provides you with a capital gains tax exclusion under the U.S. Tax Code and prevents receipt of countable cash and disqualification for Medicaid if your primary residence is sold during your lifetime and your goal is to qualify for or continue receiving MassHealth for skilled care, avoids the Medicaid lien recovery at your death, and provides your heirs with a step up in basis to fair market value at your death.
A key tax avoidance opportunity is usually missed, when real property is gifted outright. The IRS says that if someone owns real estate, when that person passes, the heirs may eliminate a large portion of the taxable gains, if the real estate ends up being sold by an heir for more than the original owner paid for the property. That is what is called a step-up in basis at death.
Let’s walk through an example of how this works. Let’s say Terry buys a home for $1,000. The cost to buy the home is referred to as a “tax basis.”
If the family is planning for the possibility of nursing home costs, Terry might want to give that home away to her children Ted and Zach. She needs to do it at least five years before she thinks she’ll need Medicaid to pay for long-term nursing care because of a five-year lookback.
When Terry gifts her primary residence to Ted and Zach, the two children acquire Terry’s tax basis of $1,000. Ted gets $500 of the tax basic credit, and so does Zach.
The years go by and Ted wants to buy out Zach’s half of the house. The property is now worth $5,000. So, Ted pays Zach $2,500 for Zach’s half of the property. At the time of the sale, Zach, as the seller, has a tax basis of $500 and realized a capital appreciation in his 50% of the real estate. He will pay capital gains taxes of 15% or 20% on the gain of $2,000.
It could be handled smarter from a tax perspective. If Terry owns the house when she dies, then Ted and Zach get the house through her will, trust or whatever estate planning method is used. If the home is worth $3,000 when Terry dies, then Ted and Zach will get a higher tax basis: $3,000 in total, or $1,500 each. By owning the house when Terry dies, she gives them the opportunity to have their tax basis (and amount that won’t be taxed if they sell to each other or to anyone else at the time of her death) adjusted to the fair market value of the property when she dies.
There’s another way to transfer ownership of the house that works even better for everyone concerned in the context of Medicaid planning and qualification. In Massachusetts, a house with equity of $893,000 is exempt for eligibility purposes. That is, the value or equity of the house is not counted to determine if someone is eligble to receive MassHealth if the house is kept in Terry’s name. Since the house is owned by Terry (that is, title is held in Terry’s individual name), at her death, the home is a probate asset and would be subject to a Medicaid lien recovery. That is, to the extent that Terry actually receives MassHealth, the state would look to be reimbursed for the total amount that she received in benefits from probate assets, including the home. To avoid the Medicaid lien recovery at death, some elder law attorneys advise their clients to transfer the ownership of their homes to their children and reserving a life estate in the property. The life estate would not be counted for MassHealth eligibility purposes, but the capital gains taxes issue would still exist if the house was sold during Terry’s lifetime. Because Terry has a property interest in her home at the time of the sale, the value of the life estate has to be calculated. MassHealth uses the Social Security Administration (SSA) Life Estate and Remainder Interest Table to calculate the value of remainder interests (that portion owned by Terry’s children) and life estate (Terrys’s share). If the sale occurs during Terry’s lifetime, her share would receive a Section 121 capital gains tax exemption, but the children would have to pay the capital gains taxes on their remainder interest. And, because the life estate has a value, Terry would receive the value of this life estate from the sale proceeds. She would then be disqualified for MassHealth until she spent her resources back down to $2,000. So, the only benefit to a life estate is the avoidance of the potential lien recovery by the state at Terry’s passing. That is, if the children did not sell the house during Terry’s lifetime and Terry had reserved a life estate in the property, at her death the life estate extinguishes and the children own the house 100%. Terry’s estate has no property interest in the home, and the real estate is not part of the estate or is not a probate asset. There is no lien recovery with a life estate. There is also the step-up in tax basis to fair market value and the avoidance or reduction in any potential capital gain taxes from a sale or transfer.
The optimal solution is one that provides a Section 121 capital gains tax exemption, provides a step-up in basis to fair market value at death, and avoids lien recovery at death. This optimal strategy is an irrevocable Medicaid asset protection trust.
Your estate planning attorney will be able to help you and your family navigate protecting your home and other assets, while benefiting from smart tax strategies.
Reference: limaohio.com (Nov. 7, 2020) “Owning real estate without jeopardizing Medicaid paying for nursing home”