John and Mary have a house worth about $500,000.00 and about $300,000.00 in a bank account. Paul & Sue also have a house worth about $500,000.00 and about $300,000.00 in a bank account. Neither couple have long-term care insurance. Thus, they start off in the same place. However, Paul and Sue decided to place their home in a Medicaid Asset Protection Trust.
Six years later, the husbands of both Mary and Sue have passed away. Unfortunately, both Mary and Sue must enter a nursing home. What can be preserved from each couple’s assets?
John and Mary did not put their home into a Medicaid Asset Protection Trust. We will assume for the purposes of discussion that a good elder law attorney can save about 40% of their assets. Thus, in our example, $320,000.00 of John & Mary’s assets can be saved. (Yes, even if Mary is on the brink of going into the nursing home, significant assets can be saved (at least in New York). The amount saved depends on her income and nursing home costs.)
However, Paul and Sue put their house in a Medicaid Asset Protection Trust, putting them $500,000.00 ahead in savings. Assuming we can save 40% of assets outside of the trust (or $120,000.00), we can save a total of $620,000.00 or about 78% of their assets. Thus, the Medicaid Asset Protection Trust resulted in significant savings for Paul & Sue that were not available to John and Mary.
A properly drafted Medicaid Asset Protection Trust will provide the following benefits:
- Ability to live in the home for the rest of your life
- Protection from creditors
- Keep STAR, veterans and other property tax exemptions
- Receipt of income from the trust (if you choose)
- Preservation of the capital gains tax exclusion upon the sale of the house (see below)
- Preservation of the step-up in basis upon death (thousands of dollars saved in capital gains taxes) (see below)
- Ability to decide who your beneficiaries will be and how their share will be distributed (see below)
- Ability to change your beneficiaries
- Your house can be sold and the proceeds used to buy another one
Capital Gains
Upon the sale of your home, if you are married and have owned and lived in your home for two out of the last five years, you will get a $500,000 exclusion from the capital gains tax upon the sale of your home. If you are single, you will get a $250,000 exclusion. With a properly drafted Medicaid Asset Protection Trust, you will still get these exclusions.
If you gave your house away to your children and they sold your home, they would get your basis for capital gains purposes. What does that mean? The basis is the amount paid for the home, plus capital improvements. For example, let us say that Paul and Sue purchased their home for $100,000 and put $150,000 into their home in capital improvements. Their basis would be $250,000. If they sold their home for $550,0000, their capital gain would be $300,000 ($550,000 – $250,000). However, because of their $500,000 exclusion, they would not pay a capital gains tax.
However, assume that Paul and Sue gave their home to their children during their lifetime. Assume further that the children have not owned and lived in the home for two out of the past five years and that the combined state and federal capital gains tax is 25%. The children will pay a capital gains tax of $75,000 on the $300,000 capital gain when the house is sold. However, if the home is placed in a properly drafted Medicaid Asset Protection Trust and the home is sold while Paul and Sue are still alive, they will enjoy the $500,000 exclusion as shown above. If the home is sold after Paul and Sue pass, the basis in the home is stepped up to the fair market value at the time of death. The capital gains taxes will be reduced or eliminated depending on how the trust is written and when they pass away.
Thus, regardless of when the sale takes place, there will be a significant savings in capital gains taxes, most likely resulting in little or no capital gains taxes being paid.
Of course, giving your home to your children outright is never a good idea for other reasons: for instance, your children’s creditors become your creditors with respect to your home. Thus, for instance, if one of your children declares bankruptcy, your home could be sold to pay off his or her creditors.
Changing Your Mind About the Distribution of Your Estate
At the time the Medicaid Asset Protection Trust was drafted, Paul and Sue believed their daughter Pam was happily married. They decided that Pam’s share of the trust estate would be distributed directly to her and not held in trust. However, later, they found out Pam is having marital problems. They changed the distribution provisions of the trust to keep Pam’s share in trust: thus, her share is protected from her husband. If need be, they could also set up a Special Needs Trust for a disabled child or deal with other issues of their beneficiaries, such as addiction or bankruptcy.
Conclusion
Medicaid Asset Protection Trusts are not for everyone. There are always advantages and disadvantages to every planning technique. However, in the right circumstances, the Medicaid Asset Protection Trust can provide significant savings.
