Which Pre-2010 Medicaid-Oriented Transfers of Homes Get a Step-up in Basis under the Modified Carryover Basis Rules?

Having written and spoken quite a bit in the past 20 years about how to transfer a person’s home for Medicaid and tax planning purposes, I’ve been getting calls and emails about how the new 2010 tax law affects common lifetime transfers of a senior citizen’s home.  Thanks to political games played during the first year George W. Bush’s presidency, we now have a tax law that only affects the estates of persons who die during 2010.  Under pre-2010 law, which comes back into effect after 2010, the tax goal in Medicaid planning was usually to render the home includable in the decedent’s gross estate for federal estate tax purposes.  Some of the methods used by estate planning and elder law attorneys may not be eligible in 2010 for a post-death adjustment in the basis for capital gains tax purposes, so some persons are trying to determine whether a change should be made in the ownership of the home.

Unless a person who made a transfer of the home is expected to die well before the end of 2010, it may be that the best course of action would be to do nothing.  We’re going through a temporary change in the law, and there have been indications from Congress that the federal estate tax laws and accompanying capital gains tax laws may be returned to 2009 law and made retroactive to the beginning of 2010.  For someone is expected to die soon, however, perhaps a change should be made. (Clients of mine in this situation should contact me immediately.)

Under the applicable 2010 tax law, known as the modified carryover basis rules, an estate can opt for a step-up in basis for certain assets, and to see whether these are eligible, Internal Revenue Code section 1022 applies.  The most common types of transfers of the home that were made for Medicaid planning purposes in the past were (1) joint tenancy with right of survivorship, (2) a reserved power of appointment in a deed, (3) an irrevocable income-only trust, which often includes a reserved power of appointment, and (4) a reserved life estate, use-and-occupancy agreement or informal understanding.  To qualify for the step-up in basis, an asset must be owned under Section 1022(d) and acquired under Section 1022(e), so each type of transfer must be analyzed.

Internal Revenue Code section 1022 (d)(1)(B)(i) allows at least a partial step-up for some joint tenancies; (d)(1)(B)(iii) denies the step-up for a reserved power of appointment, presumably only in a deed.  Section 1022(e)(2)(B) allows the step-up for some irrevocable trusts, including a power to alter or terminate the trust, which would seem to include a reserved power of appointment in an irrevocable trust. 

It has been questioned whether a life estate is entitled to a step-up in basis.  Several blog commentators have written that a life estate is not eligible for the step-up, but many of them seem to be parroting each other and not displaying their analysis.  Section 1022(e)(3) seems to include a reserved life estate but not a use-and-occupancy agreement or informal understanding.  The language in (e)(3) includes “property passing from the decedent by reason of death to the extent that such property passed without consideration,” and where the property passes to the remainderpersons upon the life tenant’s death, that description could include a reserved life estate.  Further, under Massachusetts law, the life tenant has exclusive possession of the entire property during the life tenant’s lifetime, and may therefore fit the ownership test in Section 1022(d).  Thus, it appears to me that a Massachusetts life estate can be eligible for a step-up in basis.

The National Academy of Elder Law Attorneys has written to the IRS for clarification about whether a life estate or an income-only irrevocable trust is entitled to a step-up in basis under Section 1022.  http://www.naela.org/MemberPages/documents/IRC_1022_letter_3_31_10.pdf  It’ll be interesting to see if NAELA receives an answer, but my general feeling is that Congress will eventually act, and that this modified carryover basis issue will eventually become a non-issue.

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