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Davidow, Davidow, Siegel & Stern, LLP
Long Island's Elder Law, Special Needs & Estate Planning Firm

Tuesday, November 30, 2004

Use of a Life Estate Should be Rare - Part 1

Saving the family home from the high cost of nursing homes and other long term care expenses is high on the set of priorities of most middle-class seniors. Elder law attorneys have educated clients on the various solutions to this problem over the years. Perhaps the most popular legal solution to this problem is the creation of a life estate. It is also the most overused and usually inappropriate tool we have at our disposal. Its use should be rare.

A life estate is created by preparing a new deed. The deed conveys the property, in the usual manner, from the party of the first part to the party of the second part. For example, Mom transfers her property to the names of her children. The only addition to this is that in the body of the deed, perhaps after the description of the property, the following language is inserted (or words to this effect): THE PARTY OF THE FIRST PART HEREBY RETAINS A LIFE ESTATE.

As is evident, the creation of a life estate is simple. It is a concept that all lawyers and clients can understand with ease. My contention, however, is that its simplicity breeds a climate for its inappropriate and over use.

Next week we'll explain the benefits of the life estate.

Tuesday, November 23, 2004

Use of a Life Estate Should be Rare - Part 2

Life Estate Benefits A transfer of real property by deed with a retained life estate can protect the property from having to be consiered an available asset when seeking Medicaid coverage of long term care expenses. Subject to the look-back and transfer penalty rules, at a certain time in the future, the property will be protected.

A transfer of any non-exempt asset causes a Medicaid penalty, that is an amount of months in which the Medicaid applicant will not be eligible for Medicaid. Currently the formula to determine this, on Long Island, is, subject to a three year look-back (five years if the transfer is to an irrevocable trust) that the applicant will not be elgible for Medicaid for one month for each $8,272 transferred.

One benefit of a life estate is that the value of the retained life estate itself is not considered for such transfer penalty purposes, thereby reducing the penalty period from the longer period based on the full value of the property.

The value of the retained life estate remains an asset of the Medicaid applicant, but it is at best an illiquid asset which Medicaid practically ignores. Medicaid will place a lien on this life estate value, but the lien is extinguished with the life estate itself upon the death of the life tenant.

Lawyers and their clients also love life estates because they keep seniors in control of their homes and allows them to retain all property tax exemptions.

Furthermore, upon the death of the life tenant, the reamindermen children now own the entire property, without probate, and they receive a step-up in tax basis, thereby eliminating all captial gains when the property is sold after their parents' death.

Life estates sound great. Our senior clients are in control, they have protected their homes from long term care, they have avoided probate and have preserved all tax benefits. So what could possibly be wron with the life estate technique in this context? Tune in for the answer in an upcoming newsletter.

Sunday, November 14, 2004

Use of a Life Estate Should be Rare - Part 3

SELLING THE HOUSE The problem with a life estate is that it can lead to disastrous consequences when the house is sold during the life of the life tenant.

Assuming that there is no concern with the need to obtain the consent of the remaindermen children to sell the property, there still exists tax and Medicaid problems with a sale of the senior's principal residence.

When a home is sold in a life estate situation, the sales proceeds are split between the life tenant and the remaindermen. The Federal government laid the ground work for the proper percentages to apply in this context when it published Health Care Financing Administration (HCFA) transmittal #64. To give an example of the breakdown, if the life tenant were 76 years old at the time of the sale, 50 percent of the sales proceeds would inure to the benefit of the life tenant and 50 percent to the benefit of the remaindermen. Carrying this example further, what then are the tax and Medicaid ramifications of this sale?

Let's first discuss the tax ramifications, that being whether or to what extent the principal residence capital gain exclusion (IRS 121) can be applied to this transaction. The law permits a homeowner to exclude from capital gains $250,000, provided the homeowner owned and resided in the home for at least two out of the last five years. As applied in this case, a 76-year-old life tenant would have only owned 50 percent of the property and thus would only be allowed to apply her $250,000 capital gains exclusion to the gains realized on such half. (As an aside, the IRS does not use the HCFA tables to determine the proper allocation between the life tenant and the remaindermen).

The remaindermen children, on the other hand, would not be allowed to apply any exclusion to the gain on their half, assuming they do not live with their parent(s). Therefore, a sale of a home in a life estate situation would cause capital gains to be paid on the remaindermen children's portion.

More sophisticated solutions involving irrevocable trusts solve this problem and should be offered to the clients as an alternative plan. The house can be transferred to an irrevocable grantor trust (pursuant to IRS code 674 and/or 675) and when sold during the senior's life, the full $250,000 captial gain exclusion could be applied to the entire property.

Next we'll discuss the Medicaid ramifications that must be considered with a life estate.

Next week we'll explain the benefits of the life estate.

Sunday, November 7, 2004

Use of a Life Estate Should be Rare - Part 4

The Medicaid ramifications must also be considered when using a Life Estate. If the life tenant is not on Medicaid, then in the case we have been discussing in previous newsfaxes, 50 percent of the sales proceeds will be returned to the life tenant in an unprotected manner, necessitating a transfer (subject to look backs and penalties) all over again. Now that the client is older and perhaps less healthy, we are jeopardizing the assets, albeit half, all over again.

If the life tenant is on Medicaid, then Medicaid will have placed a lien on the life tenant's portion of the property which then must be satisfied at the closing. Here, we would simply lose 50% of the property.

In either case, if the property had been transferred originally to an irrevocable grantor trust, then the sales proceeds wold have been payable to the trust, not returned to the senior. The trustee can then, if appropriate, purchase another home or otherwise invest the sales proceeds, without any further concern for the Medicaid system.

The bottom line is that a life estate poses tax and Medicaid problems during a sale of the property during the life of the life tenant. An irrevocable grantor trust will also keep the senior in control, protect their homes from long term care, avoid probate and preserve all tax benefits, but allows the senior (or her trustee) to sell the house at any time during their life without tax and Medicaid issues. The use of a life estate ties the hands of a senior because of the practical inability to sell the house during life.

When a lawyer approaches a client about this issue, the first question that should be asked is whether they are prepared to give up the right to sell their house during life. In those rare cases where the client is willing to give up all desires adn rights to sell the house during life, the life estat is the appropriate tool to use.