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When Protecting Assets Beware of Capital Gains Tax (Part 3)

            The last two weeks I have been explaining the danger of ignoring a potential capital gains tax while focusing on the avoidance of estate tax and asset protection from the cost of long term care.

            Mom wants to protect her $600,000 home from being lost to the cost of long term care.  If, however, she transfers the home outright to her children, when they sell it they’ll have to pay a pretty hefty capital gains tax because they get her carryover basis, what she paid for the home 50 years ago (see last week’s post about a “carry over” basis). If she holds onto the home and the children inherit it and sell it after she passes away they’ll save the tax because of a “step upped” basis, but that’s only if she doesn’t get sick, need a lot of care and have sell the home to pay for that care.  Is there another way to accomplish Mom’s goal?  The answer is “yes”.

            By transferring the home to a special type of trust she can preserve the step up in basis and prevent the State from forcing her to sell the home and spend down all the proceeds for care.  By tailoring a trust to meet Mom’s specific needs, ownership of the home by the trust won’t count as an asset of Mom’s.  When Mom dies, however, the home will be counted as part of her estate so her children will get the benefit of the step up in basis, wiping out all the unrealized gain and the tax on that gain.

            Trusts come and many shapes and sizes so not any trust will accomplish this result.  Consulting with an elder care attorney familiar with the Medicaid rules is a must because the trust will have to pass the State’s scrutiny if and when Medicaid is applied for.  It is equally important to do this type of planning in advance, ideally when still healthy.  That’s because while the assets inside the trust are not countable under Medicaid’s asset rules, the transfer from Mom to the trust is subject to Medicaid’s 5 year look back.