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An Analysis of the Tax and Medicaid Aspects of Various Types of Transfers of the Home

August 9, 2013

Different types of gifts and transfers of assets have very different results for tax and Medicaid purposes. The following is an analysis of the tax results of some basic types of transfers of a person’s home.

(A) Upon a transfer of a person’s home into a revocable trust…:

(1) Is there any gift tax? A completed gift has not been made, so a gift tax return would not be due.

(2) Will there be any capital gains tax upon a sale during the person’s lifetime? The $250,000.00 (or, for a married couple, $500,000.00) capital gains exclusion under Internal Revenue Code (“IRC”) Section 121 previously allowed to the person is preserved, assuming the person lived there for two (2) out of the past five (5) years.

(3) Will the home be included in the person’s gross estate? Pursuant to IRC Section 2038, the home is included in the person’s gross estate. Whether or not an estate tax will occur is based on the total of the gross estate for estate tax purposes.

(4) Upon the person’s death, what is the tax impact of the transfer on the heirs? The tax results are the same as if the person had kept the home in the person’s own name. A stepped-up basis as of the date of death will be obtained by the heirs.

(5) Is this type of transfer advisable in the Medicaid planning context? Extremely rarely, and never if nursing home costs are an issue. A home is a revocable trust often leaves a person worse off than if nothing had been done, since Medicaid law requires its sale if it remains in a revocable trust at the time of applying for Medicaid. This type of transfer could only work in a community Medicaid context, where the goal would be to avoid probate if the state looks solely to the person’s probate estate for estate recovery.

(B) Upon a transfer of the home which adds two (2) other persons as joint tenants with right of survivorship…:

(1) Is there any gift tax? A completed gift has been made of two-thirds (2/3) of the fair market value of the home, and a gift tax return should be filed.

(2) Will there be any capital gains tax upon a sale by the transferee during the person’s lifetime? If a transferee does not live in the home for two (2) years, there will be a capital gains tax. Whenever a transferee does not meet the IRC Section 121 requirements described in (A)(2) above, a capital gains tax will be imposed upon that person’s portion of the sale proceeds.

(3) Will the home be included in the giver’s gross estate? Under IRC Section 2040, financial contribution towards the purchase of the home must be traced, and since the recipients did not contribute towards the purchase, the fair market value of the home as of the giver’s death will be included in the giver’s gross estate.

(4) Upon the person’s death, what is the tax impact of the transfer on the heirs? Since the home would be fully included in the giver’s gross estate, the heirs would receive a stepped-up basis, and no capital gains tax would then result upon a sale which is made after the giver’s death.

(5) Is this type of transfer advisable in the Medicaid planning context? Sometimes, although the creditors and spouses of all joint tenants can eventually become involved in the ownership and decisions of when to sell the home. In states that have adopted the expanded estate recovery provisions of the federal Medicaid law, the giver’s reserved one-third of the home would be subject to an estate recovery claim.

(C) Upon a transfer of the home from one person to other(s) with a reserved life estate…:

(1) Is there any gift tax? A completed gift has been made of the remainder interest, but due to Chapter 14 of the Internal Revenue Code the amount of the gift to be reported on the federal gift tax return is the fair market value of the entire home on the date of the gift.

(2) Will there be any capital gains tax upon a sale during the person’s lifetime? The person’s life estate would be accorded an actuarial value at the time of the sale, and the person would be entitled to use the IRC Section 121 exclusion only to the extent of that value. Since the heirs received the remainder interest, they would be liable for capital gains tax on their share of the proceeds, unless they also met the IRC Section 121 requirements.

(3) Will the fair market value of the home be included in the giver’s gross estate? Pursuant to IRC Section 2036, the fair market value of the home would be included in the giver’s gross estate. Thus, while the giver has made a completed gift of the remainder interest, the full value of the home ends up being includable in the giver’s gross estate anyway. This result points out the practical reason that federal gift tax returns are often not filed in these cases. Another point which should be noted here is that, pursuant to IRC Section 2035, the release of a life estate is not effective for estate tax (and accompanying step-up or step-down in basis) purposes until 3 years after the date of the release; thus, for a person who wishes to make an outright gift, it may be better for estate tax purposes to reserve a life estate then later release it.

(4) Upon the giver’s death, what is the tax impact of the transfer on the heirs? The tax results are the same as if the person had kept the home in the person’s own name. A stepped-up basis will be obtained by the heirs.

(5) Is this type of transfer advisable in the Medicaid planning context? Often, as Medicaid law considers only the remainder interest to be a gift. In states that have adopted the expanded estate recovery provisions of the federal Medicaid law, the giver’s reserved life estate in the home, accorded an actuarial value as of the date of death,  would be subject to an estate recovery claim.

(D) Upon a transfer of the home to other(s) with joint (spousal) reserved life estates …:

(1) Is there any gift tax? The answer is the same as in (C)(1) above. Assuming the spouses co-owned the home prior to the transfer, the gift tax ramifications would be divided one-half (1/2) as to each spouse.

(2) Will there be any capital gains tax upon a sale during the persons’ lifetime? The answer is the same as in (C)(2) above, except that each spouse would be treated as if the spouse had been the owner of one-half (1/2) of the home prior to the transfer. If a sale occurred after the death of one of the spouses, the one-half (1/2) share of the decedent would be sold with a stepped-up basis.

(3) Will the fair market value of the home be included in either person’s gross estate? The answer is the same as in (C)(3) above, except that each spouse would be treated as if the spouse had been the owner of one-half (1/2) of the home prior to the transfer. Thus, only one-half (1/2) of the fair market value of the home would be includable in each spouse’s gross estate. (The total estate taxes due from both spouses could end up being minimized by this maneuver, since the full value of the home would not end up being includable in the surviving spouse’s gross estate.)

(4) Upon the death of both persons, what is the tax impact of the transfer on the heirs? The tax results are the same as if each person had kept one-half (1/2) of the home in the person’s own name. Upon the death of the surviving spouse, if the one-half (1/2) share of the predeceased spouse has appreciated in value, upon a sale the heirs would then have to pay a capital gains tax on that amount of appreciation.

(5) Is this type of transfer advisable in the Medicaid planning context? Often, as Medicaid law considers only the remainder interest to be a gift.  In states that have adopted the expanded estate recovery provisions of the federal Medicaid law, the giver’s reserved life estate in the home, accorded an actuarial value as of the date of death, would be subject to an estate recovery claim.

(E) Upon an outright gift of the home…:

(1) Is there any gift tax? A completed gift has been made. For gifts to persons other than the person’s spouse, a gift tax return should be filed. In most cases no gift tax would be due.

(2) Will there be any capital gains tax upon a sale by the transferee during the person’s lifetime? Unless the transferee meets the requirements described in (A)(2) above, a capital gains tax will be imposed upon the entire sale proceeds.

(3) Will the home be included in the person’s gross estate? Generally, a gifted asset is not subject to estate tax, but if the person continues to live in the home without paying fair market rent, the Internal Revenue Service (IRS) often takes the position that the full fair market value of the home is includable in the person’s gross estate as a “retained” life estate pursuant to IRC Section 2036. (See, e.g., Revenue Rulings 70-155 and 78-409.) The position of the IRS is based on an inferred agreement, understanding or assumption, as of the date of the gift, that the person would continue to live there.

(4) Upon the person’s death, what is the tax impact of the transfer on the heirs? The heirs would not have received a stepped-up basis, and a capital gains tax may then result upon a sale that is made after the person’s death. In cases where the federal and state estate and inheritance taxes would be less than the federal and state capital gains taxes, the heirs should attempt to use to their own advantage the position of the IRS described in (3) above, so as to cause inclusion of the fair market value of the home in the person’s gross estate and to receive a step-up in basis.

(5) Is this type of transfer advisable in the Medicaid planning context? Rarely, as there are often better choices for Medicaid and tax reasons.

(F) Upon a transfer of the home from one person to other(s) with a reserved special power of appointment (SPA)…:

(1) Is there any gift tax? An incomplete gift has been made, but the reporting of the gift on a federal gift tax return is required.

(2) Will there be any capital gains tax upon a sale during the person’s lifetime? At least one commentator has suggested that the retention of a SPA allows the person to be entitled to use the IRC Section 121 exclusion on the entire sale proceeds. The idea is untested, so an irrevocable grantor trust is a far safer choice if a sale is possible.

(3) Will the fair market value of the home be included in the giver’s gross estate? Pursuant to IRC Section 2038, the fair market value of the home would be included in the giver’s gross estate. Thus, while the giver has made a transfer for Medicaid purposes, the full value of the home ends up being includable in the giver’s gross estate anyway. Similar to the release of a life estate, pursuant to IRC Section 2035, the release of a SPA is not effective for estate tax (and accompanying step-up or step-down in basis) purposes until three (3) years after the date of the release; thus, for a person who wishes to make an outright gift, it may be better for estate tax purposes to reserve a SPA then later release it.

(4) Upon the person’s death, what is the tax impact of the transfer on the heirs? The tax results are the same as if the person had kept the home in the person’s own name. A stepped-up basis will be obtained by the heirs.

(5) Is this type of transfer advisable in the Medicaid planning context? Sometimes, in conjunction with a reserved life estate, although an irrevocable grantor trust can often be a better choice.

(G) Upon a transfer of the home to a Qualified Personal Residence Trust (QPRT)…:

(1) Is there any gift tax? The more valuable the home, the younger the person deeding the home into the QPRT, and the shorter the period that is selected to live there, the more likely there may be a gift tax, but a usage period can be selected to require no gift tax.

(2) Will there be any capital gains tax upon a sale during the person’s lifetime? The capital gain on a sale during the person’s selected usage period rebounds to the person if the grantor trust rules are applicable to the trust. After the selected usage period, any sale will trigger a capital gains tax.

(3) Will the fair market value of the home be included in the giver’s gross estate? Yes if the giver dies during the selected usage period. No if the person dies after the selected usage period and fulfills an appropriate rental agreement. Accordingly, shorter usage periods are usually favorable.

(4) Upon the death of the person, what is the tax impact of the transfer on the heirs? The heirs would receive a step-up in basis to the date-of-death fair market value of the home if the giver dies during the selected usage period or if the giver does not afterwards pay fair market rent. A carryover basis would apply if the person dies after the selected usage period and pays fair market rent.

(5) Is this type of transfer advisable in the Medicaid planning context? Rarely, as QPRTs are primarily done to minimize federal estate and gift taxes.

(H) Upon a transfer of the home into an irrevocable trust other than a QPRT…:

The answer to just about any tax question posed regarding an irrevocable trust is “it depends on the provisions of the trust,” but it should be noted here an irrevocable trust can be drafted to be a grantor trust and allow usage of the capital gains exclusion under IRC Section 121, as well as to allow the heirs to receive a step-up in basis under IRC Section 2036 or 2038, all while preserving the home from being treated as the person’s asset on a Medicaid application.

For detailed articles on some of the issues in this post, see the following:

Proper Medicaid Planning May Permit Keeping the Home in the Family

In Medicaid Planning, Some Trusts Can Put Elderly Persons in a Worse Position Than If They Had Taken No Action At All

Jointly-Held Assets in Massachusetts: The Good, the Bad and the Ugly

Life Estate Can Be “Retained” for Estate Tax Purposes under Internal Revenue Code Section 2036 without Being Reserved in Deed

Problems with Outright Gifts in the Medicaid Planning Context

Using Reserved Special Powers of Appointment in Medicaid Planning

A Primer for Elder Law Attorneys on Avoiding the Inadvertent Creation of General Powers of Appointment in Durable Powers of Attorney and Trusts

Doherty Case Should Cause Some Concern about Irrevocable Medicaid Trusts in Massachusetts

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