Medicaid Planning: Purchasing a Life Estate
An elderly individual who no longer wishes or is capable of living on their own may move in with a family member. The family member can provide assistance to a parent or elderly relative with their daily living needs. These arrangements usually occur out of necessity, and the family member takes in the elderly relative out of love and familial responsibility. It can also provide an opportunity to reduce the assets of the elderly individual by having that individual purchase a life estate in their relatives’ home where they will be living. This is an attractive Medicaid planning technique because it will reduce the elderly individual’s available resources which the state looks at in determining Medicaid eligibility.
Life Estate
You may be hearing the term “Life Estate” for the first time and are wondering exactly how it works. In the simplest terms, a life estate is exactly how it sounds. The purchaser of a life estate is purchasing the legal right to live in the home for their life, and upon their passing the person whom retains a remainder interest takes full legal interest in the property. When taking in an elderly relative or parent consideration should be given to the property rights of the purchaser in the life estate; the main entitlement being the legal right to live on the premises for his or her life.
Medicaid Implications
For Medicaid purposes, the funds used for the purchase will not be considered an uncompensated transfer subject to penalty as long as the life estate is purchased for fair market value and the purchaser resides in the home for at least one year after the date of the purchase.
When you transfer the life estate interest in your home to another person the value of the home is split into two distinct amounts: (1) the life estate is assigned a fair market value based on tables provided in the State Medicaid Manual. The table sets forth percentages of fair market value corresponding to the values of the life estate, and (2) the remainder interest is determined by taking the fair market value (FMV) of the home and subtracting the life estate value retained by the purchaser.
Example: 76 year old father purchases Life Estate in daughter’s home. FMV of Daughter’s home is $400,000.
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Transfer of home:
Value of home is $400,000. Utilizing the tables provided by the State Medicaid Manual the percentage of fair market value of the father’s life estate is .50441.
$400,000 X .50441 = $201,764 (Value assigned to the Life Estate)
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Remainder Interest = FMV of Home minus Life Estate Value Retained by Seller.
$400,000 – 201,764 = $198,236 (Value assigned to the Remainder Interest)
As long as the father lives in the daughter’s home for at least one year, the $201,764 will be respected as a legitimate purchase and will be removed from the father’s estate without any Medicaid penalty.
Tax Implications to the Seller
The sale of a life estate in one’s home is considered a partial sale of an interest in real estate subject to income tax on any gain realized. However, the sale would qualify for the homestead exemption under Section 121 of the Internal Revenue Code that allows for an exclusion of gain in the amount of $250,000 for a single individual ($500,000 for a married couple) as long as the requirements of the section are met. Any portion of the exclusion amount not utilized on the sale of the life estate can be used later.
Death of Life Tenant or Remainderman
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Life Tenant: If the life tenant passes, no part of the property would be included in the estate of the life tenant and the remainderman will once again own the whole property.
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Remainderman: If the remainderman should pre-decease the life tenant, the proceeds of the sale and value of the remainder interest would be included in the remainderman’s estate. If the life tenant predeceases the remainderman the value of the entire property will be included in the remainderman’s estate when he passes at a future time.
Potential Gift Tax Situation
If the value of the life estate based on the Medicaid Tables is more than the elderly relative can afford, there is the potential for a gift situation to apply. Under this situation, it would be a partial sale and partial gift of the life estate. Internal Revenue Code Section 2702 would apply, and the interest retained by the seller would be valued at Zero. Thus, the entire value of the home minus the amount received would be considered a gift. This should be discussed with our office because it may trigger substantial gift tax implications.
Conclusion:
If you are planning to take into your home an elderly relative or parent for purposes of caring for them, selling them a life estate interest in your home could be a valuable tool in reducing their assets for purposes of qualifying for Medicaid in the future. Associated legal and tax implications should be carefully considered. Please contact this office to discuss your specific situation in greater detail.
This Memorandum is based on current law and is for informational purposes only. It is important that you discuss all legal options and consequences with a qualified elder law attorney prior to any action. Should you wish to discuss your situation with us, please call (631) 424-2800 for a consultation. For additional Memoranda, please call or visit our website at www.elderlaw.pro.
