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The Hidden Costs of Transferring Your Home (Part 2)

                In my post last week I told you about Joe’s call concerning the sale of his mother’s home.  A few years ago she went to an attorney to prepare a deed transferring the home to Joe and his sister, but keeping a life estate for herself.  A life estate is a legal right to live in the home even though it was now owned by her children.  She did this because she wanted to protect it from being spent towards nursing home care.

                As I explained last week when the home is sold the life estate does equate to an ownership interest for purposes of calculating the capital gains tax, in her case about 25%.  The other 75% is considered owned by Joe and his sister.  Joe estimated the gain on the sale to be about $250,000.  Mom can exclude up to $250,000 of gain on her share so she would not owe tax on her one quarter share, however, Joe and his sister didn’t live in the home so ¾ of the gain would be subject to tax.  They will owe about $50,000 in capital gains tax depending on their tax bracket.

                I could tell Joe was getting irritated.  “Why didn’t the attorney who prepared the deed tell us about the potential for tax”, he asked me.  I told him maybe the attorney did and you just don’t remember but I obviously couldn’t say since I wasn’t there.  But I had more bad news for Joe.

                I explained to him that the life estate that Mom holds also equates to the same $100,000 value to Mom for Medicaid purposes.  This means that if Mom does not receive her share of the proceeds when the home is sold, Medicaid will treat the transfer to Joe and his sister as subject to a Medicaid penalty or period of ineligibility.  In other words, Mom has $110,000 to spend down before applying for Medicaid and not the $10,000 Joe thought she had.

                At this point he was really mad.  It turns out that the attorney that prepared the deed was a Joe’s old college roommate who doesn’t know anything about Medicaid.  While he was trying to do Joe a favor, he was completely unaware of these other issues because it is not his area of expertise.  Joe asked him to prepare the deed and that’s what he did.  When he calmed down, Joe then asked me if there is a way out of this mess.

                I told him that holding onto the home and not selling it now would avoid the Medicaid issue for now.   Assuming Mom meets all the other qualifications, she can be approved for benefits without selling the home.  The State will probably attempt to assert a lien on the home after she dies but that would be better than selling the home and spending down her share at a much higher rate per month than what Medicaid would be paying and then attempting to recover after she dies.  Joe would, however, still have the same capital gains tax issue to contend with.  That we can’t avoid.

                And what could Joe’s mom have done instead that would have gotten them a better outcome?  Had they gone to an elder law attorney familiar with these issues, Mom could have established an irrevocable trust that would have exempted the entire value of the home for Medicaid purposes and when sold could have excluded the entire gain from tax.

The lesson to be learned is clear.  We live in a very specialized world.  It is important to get the proper advice from the right source.  There is also a lesson for attorneys.  Trying to do a favor for a friend or client could cause more harm than good.  A simple solution may not be so simple after all.