In my practice, one of the most commonly requested legal services is for the preparation of a deed transferring the client’s home to their children, with the parents reserving a “life estate” interest in the home. The general purpose of such an arrangement – often referred to as a “life estate deed” -- is to protect the home if the parents someday need long-term care assistance and hope to qualify for Medicaid. However, under virtually any situation transferring a home to a Medicaid Asset Protection Trust (“MAPT”) is a better option than use of a life estate deed.
If successfully implemented, both the life estate deed and the MAPT will protect a primary residence so long as the homeowner does not apply for Medicaid long-term care coverage for at least five years from the date the strategy is implemented. But the MAPT has a number of significant advantages over the life estate deed that makes the MAPT the strategy of choice. Here are some of the key differences:
- If the home is sold after being conveyed to the MAPT, the entire capital gain will qualify for the capital gain exemption that is available only to owners of a primary residence ($250,000 exemption for individuals, $500,000 for married couples). By contrast, if the home is sold after being conveyed via a life estate deed, the portion of the home that has been transferred to the “remainder beneficiaries” – that is, the children – will be subject to capital gains tax.
Example: A 73-year-old widow transfers her home to her two children, who both reside in New York, using the life estate deed technique. Two years later the widow decides to sell her home and move in with one of her children. The home, which has a cost basis of $50,000, is sold for $250,000. Under the federal government’s life estate tables, the children’s remainder interest is about 48% of the total property value. Since the capital gain from the sale is $200,000, the children will have to pay a capital gains tax of about $20,000 (based on the approximately 20% state and federal capital gains tax on the children’s $96,000 portion of the gain). A similar sale from a MAPT will result in the payment of no capital gains tax, as the entire sale proceeds are deemed to “belong” to the widow for capital gains tax purposes.
- A transfer to children via a life estate deed is typically an irrevocable transfer. If a parent later has a falling-out with a child, the parent will be unable to “undo” the transfer made under the deed. By contrast, a properly structured MAPT will include a “limited power of appointment” that permits the parent to change the trust beneficiaries during the parent’s lifetime, and retains for the parent the right to decide who receives the trust assets after the time of the parent’s death.
- If a parent someday enters a nursing home and the children elect to sell the parent’s residence, with the life estate deed technique Medicaid will be entitled to reimbursement for the portion of the sale proceeds equal to the value of the parent’s remaining life estate interest at the time of sale. So, if a 75-year-old is on Medicaid and the home is sold for $250,000, Medicaid will be entitled to reimbursement for the parent’s 52% portion of the sale proceeds (or $130,000). In contrast, there is no Medicaid reimbursement requirement if a residence held by a MAPT is sold while the parent is receiving Medicaid assistance.
This is a very one-sided example in favor of a MAPT vs. a life estate deed and does not fairly represent the pros and cons of one vs. the other. For instance, the exmple notes that capital gains tax would have to be paid if the home were sold out of a life estate deed. However, capital gains would be deminimus, if any at all, since the tax basis of the home would have stepped-up when the life estate deed was created. (Since property values have actually declined in the last few years, there would be no capital gain.) Also, the example also notes that 52% of the sale proceeds would not be Medicaid sheltered...but that is only because in the example the life estate deed had existed for only 2 years. If it had existed for 5 years, nealy all of the proceeds would have been sheltered. Why give such a biased view of one alternative vs. another?... because MAPT's are costly to enter into and lawyers make much more money setting them up compared to the easy establishment of a life estate deed.
ReplyDeleteSorry for the late reply, but your assertions are simply incorrect, and I stand by every word of my post. There is no stepped-up basis for the remainder interest with a life estate deed IF the home is sold during the life tenant's lifetime; that is, while the life tenant can claim the Section 121 exemption on their life estate interest, the remaindermen (unless they too live in the home) will have to pay capital gains on their interest, using the life tenant's carry-over basis (which is often very low). Regarding Medicaid protection, if the home home is sold while the life tenant is on Medicaid, the value of the life estate IS subject to Medicaid repayment EVEN IF the home is sold more than five years after the life estate deed is signed. With a MAPT, there would be no similar repayment obligation.
ReplyDeleteI appreciate the feedback regardless!
My Mom lives in N.y and has a life estate and named my sister and I remaindermen. My mom is still living but my sister passed away. Does my sister's.two children get her share when my mom passes away?
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