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The Heritage Law Center, LLC Blog

Should a Life Estate be used to Protect the Home from Medicaid?

POSTED ON: March 28, 2013

Recently, I worked with a client whose mother had transferred him her house and retained a life estate. The transfer occurred ten years ago with the goal of keeping the house safe from long-term care costs should she seek MassHealth (Medicaid) qualification. Two years ago, when the mother was 84 years old she entered a nursing home as a MassHealth recipient. She qualified right away because her life estate was not counted as an asset for MassHealth purposes, however she has been unable to return home and carrying the costs of the home were starting to strain the son’s finances. He wanted to sell the house and asked me how this would affect his mother’s MassHealth eligibility.

My answer wasn’t exactly what he wanted to hear, but it serves as a good lesson for anyone considering using a life estate as an asset protection tool. While creating a life-estate can be a good option in the right circumstances, it is almost never the best option.

When you create a life-estate you are essentially splitting the ownership of the home into two: the present interest (Mom) and the future interest (the son). This restricts either party’s ability to sell the house without the other party’s consent. It also means that as long as the house is not sold during the mother’s life her life-estate has no value for MassHealth purposes. However, once the house is sold she will be entitled to a sum of money equal to her life-estate interest. For example, according to the Social Security Life Expectancy Table an 86 year old’s life-estate interest in the home is equal to approximately 33%.

Assume the son sold the home and that the net proceeds from the sale was $330,000.00. One third of the net proceeds ($110,000.00) will be payable to his mother for her life estate interest. Because MassHealth asset guidelines allow a single person to have only $2,000 in their name, once the house is sold and she received $110,000.00 she will no longer be eligible for MassHealth and will have to pay privately for her care until her assets are back down to $2,000. In this scenario a substantial portion of the house sale proceeds would be taken to pay for nursing home care.

It is important to note that were his mother to decide not to accept the proceeds of the sale of the home, it will still be considered a transfer of the full value and be treated no differently than had she taken the money resulting in a penalty being assessed despite her never receiving the money.

Another important consideration when creating a life-estate is the capital gains tax implications. Since the property is not the son’s primary residence he is not entitled to a capital gains exemption on his share of the proceeds. Accordingly, capital gains taxes will have to be paid on any appreciation from the date his mother bought the property to the day of sale, reducing his share by approximately 25%. His mother could apply her $250,000.00 capital gains exemption to her share of the proceeds since she lived at the premises at least two of the last five years and no capital gains tax will be due on her share of the proceeds.

A much more preferable outcome could have been achieved by deeding the house to an irrevocable trust. Using an irrevocable trust, the mother would retain the right to sell the house and purchase a new property without involving her son. After MassHealth’s five year look-back had been achieved, the house would not be countable as an asset by MassHealth and when the mother passed away the son would have received the property with a ‘stepped up basis,’ meaning no capital gains taxes would have been due.

One alternative available current life-estate holders is to rent the home and not sell until life tenant’s death. Under the MassHealth rules, you can use the rental income to pay the carrying charges on the premises. These expenses include but are not limited to: real estate taxes, homeowners insurance, utilities, landscaping, maintenance and repairs. Any rental income in excess of the carrying charges will be considered income to the MassHealth recipient in the month received and will have to be paid to the nursing home. This may enable you to hold onto the house and avoid losing a substantial portion of the proceeds to nursing home charges and capital gains taxes, however, putting the right plan in place from the beginning offers the most flexibility and protection and is obviously preferred.

If you have questions about the benefits and pitfalls of life-estate and irrevocable trust planning or asset protection, call the Heritage Law Center for a free consultation today.