Your home is probably your most valuable asset. It is also probably the easiest asset for you to protect in the event that you need Medicaid to pay for your long-term care (home care, assisted living or nursing home care). Unless you are going to need the equity from your home for your support, you can transfer your home to a life estate or a living trust and avoid losing it in the event that you need such care. In this article, we are going to discuss the advantages and disadvantages of transferring your home to a life estate or to a trust for the purpose of Medicaid protection.
You will note that we are not discussing the possibility of transferring the home outright to one’s children. That is because transferring your home directly to your children is a terrible idea. Once your home is transferred, you no longer own it and you no longer have the right to remain in your own home. Even if you trust your child, do you trust your child’s spouse? (If your child passes away, your child’s spouse will probably be beneficiary of his or her estate and thus, the owner of your home.) Furthermore, you will lose your senior citizenship and other property tax exemptions. Your children may be required to pay thousands of dollars in capital gains taxes that they would not have been required to pay if the house was not transferred directly to them. Because we can think of no good reason to transfer your home directly to your children, we will proceed to speak about life estates and trusts.
What is a life estate? A life estate divides your home into two interests. One interest is owned by the life tenants (the parents). The other interest is owned by the remainder persons (the children). The life tenants have the right to live in the home for the rest of their lives. If the home is rented out, the life tenant is entitled to the rental income. The life tenant is responsible for payment of all of the expenses of the home, such as, property taxes, insurance and assessments.
What is a living trust? A living trust is a contract between the Creator (the parent) and the trustee (can be a child or children). (The Creator may also be called the “Settlor,” “Grantor” or “Trustor.”) The property is transferred into the trust and the trustee is obligated to manage the property in accordance with the terms of the trust document. Trusts have many purposes but we are only going to discuss Medicaid protection here.
Whether you transfer your house into a life estate or you transfer it into a living trust, there is a five year look back period with respect to nursing home Medicaid. In both cases, you have the right to live in your home for the rest of your life. In both cases, you will keep your senior and other property tax exemptions. In both cases, your children will receive a step up in basis upon your passing, thus, wiping out any capital gains taxes up to the time of your death. In both cases, you will avoid having to probate your home. In both cases, you will need to change your homeowner’s insurance to reflect the change in ownership of your home.
However, there are substantial differences between placing your home into a life estate or into a living trust. In my opinion, the trust is a much superior Medicaid planning vehicle for reasons that will be discussed below.
The first situation that we will look at is what happens if the life tenant of a life estate goes into a nursing home as opposed to the beneficiary of a trust going into a nursing home. With a life estate, the children will have four options if their parent goes into the nursing home:
- Rent the home. In my experience, most children do not wish to become landlords.
- Move into the home themselves. Most children have their own home so this is not a viable option.
- Leave the home vacant. Do I need to say more?
- Sell the home. However, remember that the life tenant (parent) still has an interest in the property. That interest has a value. If the home is sold, the life tenant will receive the value of his or her life estate from the proceeds of sale. At least part of this money will be used to pay for the parent’s nursing home care. The children will receive the other portion and this portion will be preserved with respect to Medicaid. However, the bad news is that the children will have to pay capital gains taxes on their share of the proceeds. The capital gains taxes will probably cost them tens of thousands of dollars.
With a living trust, the children will not be faced with the above terrible choices. The home can be sold by the trustee and the parent will not receive a share of the sale proceeds. Furthermore, the trust can be drafted so that the capital gains taxes will be taxed to the parent, which means that they can probably utilize their exemption amounts of $250,000 for a single person and $500,000 for a married couple. In other words, it is unlikely that any capital gains taxes will be due. Thus, if the parent goes into a nursing home, the living trust is a more desirable Medicaid planning technique than the life estate.
With a life estate, there is also a concern about what happens if one of the children predeceases the parent. The parent will have no control over who will receive the interest in the house because the ownership will pass in accordance with the child’s estate plan and not in accordance with the estate plan of the parent. Many children have their spouses as their estate beneficiaries and that is who will receive the interest in the home if the child passes away. On the other hand, the living trust determines who would get the home in the event the child predeceases the parent. Most parents would want their grandchildren to receive their predeceased child’s share of their property and a living trust will ensure that the parents’ wishes are carried out. For this reason, the trust is the better Medicaid plan.
With a life estate, a child’s creditors might be able to acquire his or her share of the home. Some years ago, there was a story in Newsday that illustrated how this can happen. A mother created a life estate and her son and daughter were the remainder persons. Unfortunately, the son had to declare bankruptcy. Because the son owned a remainder interest in his mother’s property (and this interest has a value), the bankruptcy trustee decided to sell the son’s interest in the home to a third-party. Thus, the son lost his share of the remainder interest in his mother’s home. Furthermore, once the mother passes, the daughter will now own the home with a complete stranger. If the home had been in a living trust, this problem could have been avoided. Again, the trust comes out on top as the better Medicaid plan.
What if the parent wants to sell the home and move someplace else? With a life estate, the parent is only entitled to that portion of the proceeds that represents the life estate. The children receive the rest of the proceeds. However, with a trust, the trustee can sell the home and use the entire proceeds of sale to buy another home for the parent. The parent will also receive the capital gains tax advantages that were mentioned above.
With a living trust, the parent can change her mind as to who will be her beneficiaries. With the life estate, the parent has transferred ownership to the beneficiaries and cannot change her mind about giving her home to them.
Both the life estate and the living trust offer Medicaid protection. However, because of the above stated reasons, for most people, the living trust is the better alternative.