Life Estates & Long Term Care
Life Estates have been frequently used by property owners as a means of asset protection in event that the property owner needs long term care in a nursing home. A "life estate" is a "tenancy" or means of owning property where the life tenant has ownership of the property for life with other persons, usually the owner's children, holding the "remainder," that is the right to own the property upon the death of of some person or persons, usually the life tenant.
The advantage of a life estate in estate planning or planning for long term nursing care is that the life tenant can enjoy full use of the property (as long as he does not waste the property). Another advantage is that upon the death of the life tenant, the owner of the remainder receives a stepped up tax basis in the property. This would allow the new owners to sell the property using value of the property at the time of death as the property's new "tax basis." If the previous owner had sold the property prior to death, he would have had to pay a capital gains tax on the difference between the amount he had paid for the property and the amount for which the property was sold. The new owner only pays capital gains tax on the difference between the value of the property at the time of death and the amount for which the property sold. There is also the advantage that life estates are not counted as an available resource for medicaid purposes.
Life estates are an improvement over simply gifting the property in that the life tenant's interest in the property is not put at risk by the actions of the remainder owners. If the owner had made an outright gift of the property to his children and the children were to divorce or get into problem with debt, the property could be lost because of something that happened to the owner's children. If a life estate is used the owner's children may lose their remainder interest, but the owner's life estate will not be affected.
The main advantage of using life estates is that it is inexpensive. It usually can be done for the cost of preparing a deed. There are however significant disadvantages to using life estates.
The problem with using life estates for long term care is that Medicaid rules now provide that upon the death of the person receiving Medicaid for long term care that Medicaid is entitled to recover from the estate of the recipient, "All real and personal property or other assets in which the deceased recipient had legal title or interest at the time of death, to the extent of the recipient’s interest, whether the asset was conveyed to a survivor, heir or assign of the deceased recipient through joint tenancy, tenancy in common survivorship, life estate, living trust or other arrangement." The amount that can be recovered from a life estate is the value of the life estate at the date of death based on actuarial tables. While Medicaid Recovery may not have been aggressive in the past on recovering from life estates, it is becoming more common and using a life estate cannot be considered a reliable way to protect property from Medicaid.
There are other disadvantages to life estates. If the property needs to be sold, all of the owners of the property, including the remainder owners are required to agree, including the spouses of the remainder owners. If one of the remainder owners is a minor child, a court ordered guardianship would be required to transfer title. If the property contains timber, and there is a need or desire to sell timber, the remainder owners my have a claim to the timber. Also, using a life estate does nothing to protect remainder owner's interest in the property from debt or divorce.
A special kind of irrevocable trust provides effective protection against Medicaid. In order to provide protection from Medicaid Recover the trust must not permit the trustee, under any circumstances, to distribute any of the principal assets held by the trust to the applicant or his or her spouse. This means that if a farm or other property is placed into the trust, it could not be sold and the proceeds distributed to the applicant or his or her spouse. The property can be sold and the proceeds could be distributed to other trust beneficiaries, but under no circumstances could they be delivered to the applicant for Medicaid.
The income or rent from the property can be retained by the owner, but that income would be a countable resource. Additionally, the owner can reserve the right to change trustees and even the beneficiaries upon the owner's death. One further advantage is that the trust can be structured in such a way that upon the owner's death, the property gets a “step-up” in its tax basis so that the farmer’s children can sell the property with minimal capital gains tax. Additionally, the trust can be structured to provide asset protection to the owner's children or future beneficiaries.
The main disadvantage to such trusts is that it is more expensive (but usually less expensive than a month's stay in the nursing home). If the trust generates income, it can also require some additional bookkeeping and there is some additional steps required when preparing the owner's income tax return.
If you are concerned about the potential loss of assets due to the need for long term care, you should consult with an attorney with experience in Medicaid Planning.