While most seniors have a will and other end of life plans in place, they often unknowingly leave one of their most valuable assets unprotected. Under federal and state law, states must seek to recover long-term care benefits from a Medicaid recipient's estate after the recipient's death. Therefore, if you fail to protect your house, it could be sold to settle the claim.

Likelihood of Seniors Needing Long-Term Care

As we age, we generally fail to recognize that at some point we can become incapacitated. In reality, the likelihood that a senior citizen will become physically or cognitively impaired in their lifetime is two in three. While family members often serve as caregivers, there are countless situations where long-term care is required.

While many of us do not foresee needing to reside in a nursing home, the chance that a senior citizen will enter a nursing home is actually one in three. Unfortunately, the costs of a nursing home room are staggering. In New Jersey, the average monthly cost of a semi-private room is $11,254, while a private room is $12,151. Additionally, the average nursing home stay is three years, which means the cost could be several hundreds of thousands of dollars.

Steps to Protect Your Home from Medicaid Recovery

When a Medicaid beneficiary dies, the value of their estate must be used to pay back debts before any assets are transferred to the person's heirs. Under certain circumstances, Medicaid can seek repayment of some costs for services from the estate.

In many states, including New Jersey, Medicaid considers the home a countable asset unless it is occupied by the community spouse, a child under age 21, a child of any age who is blind or disabled, a child who qualifies as a caregiver, or a sibling who has resided in the home for at least one year and has had an equitable interest in the home for at least one year (the protected class).

However, on the death of the Medicaid recipient, if the home is a probate asset, the state will assert estate recovery. If the home is occupied by a member of the protected class, Medicaid will assert estate recovery but will permit the member of the protected class to remain in the property. When the property is sold or on the subsequent death of the protected class member, the estate recovery lien must be satisfied. If the home is owned as tenants by the entirety or jointly with right of survivorship, estate recovery will be asserted in those states that have adopted the broad definition of "estate," which includes New Jersey.

Transferring Your Home to a Child

In order to protect the home, parents often transfer it to their children. Clients must be aware of the carryover basis by which the parents' cost basis in the home will carry over to the child. If the child lives in the home for a period of two years after obtaining ownership, then the child may satisfy the requirements pertaining to the sale of a principal residence. Unless the child meets the principal residence exclusion, there will be significant capital gains tax on the sale of the parent's home by the child.

From a Medicaid standpoint, the transfer of the home to a child who is not a member of the protected class is subject to the five-year lookback. The transfer is subject to the Medicaid transfer penalties. If there is a Medicaid transfer penalty, it is calculated by dividing the uncompensated value of the transfer by the statewide monthly average of the lowest semiprivate room rate in Medicaid-certified nursing facilities. Currently, in New Jersey, the transfer penalty is $11,388 per month.

When property is transferred from parent to child, the casualty insurance policy should also be changed. Insurance companies usually permit the homeowner's policy to remain in effect if the parent reserves a life estate, but usually do not permit the homeowner's policy to remain in effect if a life estate is not reserved.

It is important to note that here are state real estate tax consequences of transferring a home and reserving a life estate. In many states, like New Jersey, senior citizens are given certain tax benefits, such as homestead tax rebates, Veterans' deductions, and senior citizens deductions. State law must be consulted to determine if the retention of the life estate will serve to allow the client to continue to receive those benefits.

Retaining a Life Estate in Your Home

A variation of the strategy of transferring a home to a child outright is transferring the home to the child and retaining a life estate for the parent. The retention of a life estate usually makes the parent more comfortable in making the transfer. One of the benefits of transferring the home and retaining the life estate is that the Medicaid period of ineligibility is reduced. The transfer is only for the value of the remainder interest.

For example, if an 80-year-old New Jersey person transfers a home worth $1,000,000 to a child and the divisor is $11,388 per month, the penalty is 48 months. However, if the same parent transfers the home to the child and retains a life estate, the penalty is significantly reduced. The calculation looks like this:

$1,000,000.00 (value of home)
× 0.536 (remainder factor)
---------------
$536,000 (uncompensated value of transfer)
 ÷  $11,388 (average cost of nursing home)
---------------  
48 Months - Period of Ineligibility

An additional benefit is that if the home is not sold during the lifetime of the parent, because of the retained life estate the child will receive a "step up" in basis on the death of the parent. The "downside" is that the home is part of the decedent's estate. Fortunately, as a result of estate tax repeal New Jersey has eliminate its estate tax.

In states where estate recovery is asserted against the probate estate (like New Jersey), the value of the life estate would not be included in estate recovery. Some of the states using the broad definition of an "estate," including life estates, have taken the position that the value of a life estate at death is zero; other states using the broad definition have claimed that the life estate is valued at the moment before death. At the present time, in most instances, New Jersey does not seek a recovery against the life estate.

The disadvantage to transferring the home and retaining a life estate is that if the home is sold during the lifetime of the parent, the parent would be entitled to a portion of the proceeds of sale represented by the value of the parent's life estate (refer to the above example). Receipt of these proceeds of sale would disqualify the parent from Medicaid because the parent would be over resourced. If the parent met the requirements of IRC § 121, the value of the life estate would be sheltered as a principal residence, but the value of the remainder would not and the children will be subject to capital gains tax.

Retaining the Right to Use and Occupy

A variation on the retention of a life estate is to retain a right to use and occupy. Under a right to use and occupy, the parent does not reserve the right to receive rent or any portion of the proceeds of sale. The disadvantage to the right to use and occupy is that there is a complete loss of the Section 121 Exclusion on the Sale of the Principal Residence because all of the proceeds would go to the children who, presumably, would not qualify. In which case, the entire amount would be subject to capital gains tax.

Reserving a Special Power of Appointment

Another alternative to the reservation of a life estate, grantors may reserve a special power of appointment. For Medicaid purposes, the transfer of property when grantors cannot recover the property for their own benefit is a completed transfer. The special power of appointment is a "personal privilege" and not an interest in property. Therefore, it should not be subject to Medicaid estate recovery. For gift tax purposes, however, the gift will not be complete. In addition, the grantors' reservation of the special power gives them continuing influence over their issue and flexibility to deal with their children's deaths, divorces, or bankruptcies. Moreover, unlike the life estate the special power of appointment allows for a step-up in basis after death.

This power of appointment may be reserved in an income only trust into which property (such as your residence) and may be transferred. In the deed of transfer, a grantor can reserve a life estate. In such a trust, the principal is retained and is payable to the beneficiaries other than the grantor. The funding of the trust triggers the Medicaid lookback period.

Key Takeaway for Seniors

Safeguarding your home from a Medicaid lien should be a key consideration in your estate plan. As highlighted above, there are several steps that seniors can take, all of which can have both advantages and disadvantages. To determine the best possible approach for your circumstances, it is important to consult with an experienced estate planning attorney.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.