Life estates have historically been used as part of Medicaid planning. A life estate can be described as a form of co-ownership of property between a “life tenant” and a “remainderman.” To own a life estate means the person, referred to as the life tenant, has the right to the use and possession of the property during his/her lifetime, similar to an owner. Upon his/her death, another individual, called the remainderman, will become the owner of the property. Such co-ownership gives the life tenant and remainderman each a set of rights to the property and a monetary value attached to those rights. Life estates are used because they often accomplish multiple beneficial goals in addition to Medicaid eligibility. Since the passage of the Deficit Reduction Act of 2005, changes regarding life estates have been implemented in Medicaid planning. The major change has been the method of valuing life estates.
The use of a life estate when one person plans to transfer property to another is often beneficial for capital gains tax purposes. When an individual (grantor/donor) transfers property outright (makes a “gift”) to another person (recipient/donee), the recipient of the gift takes on the cost basis of that property (what the grantor paid for the property plus any capital improvements), known as the “carry over basis”. In other words, if an individual transfers a home purchased in 1958 for $58,000 and the home is now valued at $758,000, the recipient will have a basis of $58,000 and will pay capital gains tax on the $700,000 gain/profit upon the sale of the property. However, if the grantor retains a life estate in the property and the house is not sold during the grantor’s lifetime, the recipient will essentially inherit the property, and the basis will be the value of the property on the donor’s date of death, i.e. “stepped up basis,” thereby minimizing or eliminating capital gains tax on the sale.
For Medicaid purposes, the value of a life estate is looked at to determine how much of the property was transferred or “gifted” to the remainderman, if the grantor requires nursing home Medicaid within 5 years of the transfer. For nursing home Medicaid, any type of transfer of assets without compensation for fair market value is presumed to be a gift, and Medicaid imposes a penalty on all gifts. When a Medicaid applicant transfers his/her house but retains a life estate, the individual is considered to have gifted not the value of the entire property but the value of the property less the value of the life estate that he/she retained. Medicaid can only impose a penalty on the portion “gifted” to the remainderman. Medicaid uses charts to value life estates. So, for example, pursuant to IRS tables, if the federal mid-term interest rate is 2% at the time of the transfer, the life estate for a 75 year-old is valued at .19077. Therefore, if a 75 year-old transfers her $758,000 house and retains a life estate, Medicaid will value the life estate at $144,603.66 and the resulting value of the “gift” is $613,396.34. Medicaid can impose a penalty on $613,396.34, not on the entire value of the property.
Prior to the DRA, life estates were valued at a larger percentage of the value of the home. For example, prior to the DRA the value of a life estate for a 75 year-old was valued at .52149. Therefore, in the above example, the life estate value would have been $395,289.42 and the resulting value of the “gift” would have been $362,710.58.
Another change resulting from the DRA specifically affects life estates that are purchased. Life estates can be retained or purchased on a property. A life estate is retained when the owner transfers the property to another but keeps a life estate (or reserves the right of a life estate). A life estate is purchased when an individual buys a life estate in another person’s home. For example, an elderly person’s child may have plans to move the parent into his/her home in order to provide care and in that case, the elderly individual can legitimately spend down some of his/her assets by purchasing a right to remain in the child’s home. After the DRA, in order for the purchase of a life estate to be considered a compensated transfer and not a gift for Medicaid purposes, the individual buying the life estate must reside in the home for at least one year after the purchase. The individual must also be able to show sufficient proof of such residency. In a recently decided case, Albino v. Shah, a woman who owned a life estate on property #1 purchased a life estate on property #2, bought by her daughter and grandson. Thirteen months later she became a resident of an assisted living facility. About a year after that she fell and broke her hip and was ultimately admitted into a nursing home.
At a fair hearing it was decided that her tax returns listed property #1 as her address, as did her driver’s license and registration with the Board of Elections. Although she provided undated mail sent to the second property, it was not enough evidence to overturn the decision of the fair hearing and the lower court. The funds used to purchase the life estate on property #2 were deemed a transfer of assets/gift, rather than a compensated transfer, resulting in a period of ineligibility for nursing home Medicaid.