Transferring one’s home to another person or persons, subject to a life estate, has been a staple strategy of elder law planning for a very long time. Medicaid planning typically involves an individual divesting himself/herself of assets in order to become eligible for long term care coverage via the Medicaid program at some point in the future. Often, when engaging in Medicaid planning, one is faced with negative tax consequences when transferring assets directly to others.
For example, in the context of real estate, if a person transfers real property to another without any strings attached, the recipient will receive a carryover basis in the property. (The term “basis” means cost.) If Mr. Abrams paid $50,000 for his home, his basis is $50,000. One’s basis in a home can be increased by the cost of any capital improvements made to the home. If the home is currently worth $500,000 and Mr. Abrams transfers it to his daughter, her basis will now be $50,000 (regardless of the current fair market value). The reason this is significant is because when Mr. Abrams’ daughter goes to sell the house, she will have capital gains of $450,000 and this gain will be subject to a 20 percent Federal tax as well as an additional New York State tax. If Mr. Abrams had retained the property and died with the property in his name, his daughter would have received a step up in basis, meaning her basis would be the value of the property at the time of Mr. Abrams’ death rather than what he paid for it. If the daughter were to sell the property soon afterward, she would have zero capital gains taxes. When we do planning, it is understandable that there will sometimes be negative side effects, but our goal is to minimize or eliminate them.
One way to avoid the recipient getting a carryover basis (which therefore results in potentially onerous capital gains tax consequences) is to add life estate language to the deed transfer. So, if Mr. Abrams transfers his real estate to his daughter but retains the legal right to the enjoyment, use and possession of the property, i.e., the property is transferred to his daughter subject to a life estate, she will get a step up in basis upon her father’s death. As far as Medicaid planning is involved, the result is the same. Mr. Abrams, during his lifetime, effectively divested himself of his home – thereby protecting it - by transferring it to his daughter. But because he retained a life estate, his daughter did not become the true owner until after Mr. Abrams’ demise, resulting in a complete step up in basis and zero capital gains taxes upon the ultimate sale.
Many ancillary questions arise in connection with transferring real property subject to a life estate. In our example, what if Mr. Abrams’ daughter decides to sell the property while he is still alive? What if she wishes to transfer the property to one of her siblings? If the daughter wishes to transfer the property to someone else, this will not affect Mr. Abrams’ Medicaid eligibility. The daughter will have to include Mr. Abrams’ life estate interest in the deed transfer so that ultimately, the property does not entirely vest in the transferee until Mr. Abrams’ demise.
The sale of property subject to a life estate while the life estate holder is still alive is more complicated. Firstly, there will be negative capital gains taxes because the only way the house can be sold is if the life estate is extinguished. In other words, Mr. Abrams can no longer have the right to reside in a house that is being sold. Therefore, for purposes of the sale, the daughter’s basis will now be the carryover basis and the daughter will be taxed on any gain. Further, the sale of the home will result in a portion of the proceeds going back into Mr. Abrams’ name. In the context of the sale, the life estate owned by Mr. Abrams has a certain value based upon his age. Accordingly, the portion of the sales proceeds attributable to Mr. Abrams’ life estate will be payable to him and this will not be helpful if Mr. Abrams is either on Medicaid or attempting to become eligible.
Due to some of the complications that may arise from the transfer of real estate subject to a life estate, we often recommend irrevocable trusts as a more flexible alternative. The specific facts of each situation ultimately dictate the optimal way to preserve and transfer one’s real estate. Discussing these options with an experienced estate planning elder law attorney is highly advisable.
This summary is not legal advice and does not create any attorney-client relationship. This summary does not provide a definitive legal opinion for any factual situation. Before the firm can provide legal advice or opinion to any person or entity, the specific facts at issue must be reviewed by the firm. Before an attorney-client relationship is formed, the firm must have a signed engagement letter with a client setting forth the Firm’s scope and terms of representation.
Ronald A. Fatoullah, Esq. is the founder of Ronald Fatoullah & Associates, a law firm that concentrates in elder law, estate planning, Medicaid planning, guardianships, estate administration, trusts, wills, and real estate. Debby Rosenfeld, Esq. is a senior staff attorney at the firm. The law firm can be reached at 718-261-1700, 516-466-4422, or toll free at 1-877-ELDER-LAW or 1-877-ESTATES. Mr. Fatoullah is also a partner with Brightside Advisors, a wealth management firm with offices in New York and Los Angeles.