In the last article, we looked at the general characteristics of various ways of owning real property, namely: fee simple, tenancy in common, joint tenancy with rights of survivorship, and life estates. I have “hotlinked” each property type so you can go back for a “refresher.”
Now that you have a basic understanding of ways of holding real property, understanding how those different ownership interests impact Medicaid (and how Medicaid impacts those interests — especially if you’re interested in keeping that property) is very important. As we’ll see, the various ownership interests also have different tax impacts.
Fee Simple Ownership
Medicaid: Unless the property owned is a residence, real property held in fee simple is countable for purposes of Medicaid eligibility. Also, even if the property is a residence, although noncountable for purposes of eligibility, the property will likely be available for estate recovery purposes.
Taxes: If the property is a person’s principal residence, the first $250,000 of capital gain is tax free ($500,000 for a couple). If the property is a principal residence, sale of the property will likely generate taxable capital gain. You can read a bit more about capital gains taxes here.
People inheriting the property will receive “stepped up” basis equal to the value of the property on the date of the death that triggered receipt of the property. This could completely avoid capital gains tax on the kids that Mom and Dad would have paid if they had sold the property before they died (assuming the property was nonresidential). Again, you can read a bit more about capital gains taxes here.
Probate: Unless the property is held in a trust, it will be subject to probate proceedings at death of the owner.
Tenancy in Common
Medicaid: Not countable, BUT subject to estate recovery.
Taxes: Same rules as fee simple ownership discussed above.
Probate: Same rules as fee simple ownership discussed above.
Joint Tenancy with Rights of Survivorship
Medicaid: Not countable. Currently not subject to estate recovery. According to old common law (court rulings going back many years as well as “commonly accepted” understandings of the law) joint tenancies pass free of the claims of creditors against a deceased joint tenant. There is also a 62 year-old North Carolina Supreme Court case that says that is the case. Wilson County v. Wooten, 251 N.C. 667, 670 (1960). But that’s it. The General Assembly could change this if it had the political will to do so. So, bottom line: Joint tenancies currently work to avoid estate recovery. If there is a more solid strategy available, however, I use it.
Note: Many people avoid or minimize transfer penalties by simply giving someone a 1% joint tenancy with rights of survivorship interest. That way, they have made a very small (1%) gift subject to a transfer penalty. Or the person receiving the 1% might pay for it and avoid a transfer penalty completely.
Taxes: Same as tenancy in common interests discussed above.
Probate: Avoids probate.
Tenancies by the Entireties
Medicaid: Unless the real property is the residence, tenancy by the entireties property owned by the married couple will be countable. This property will need to be converted to a joint tenancy with rights of survivorship to become noncountable (perhaps by giving a child 1% and holding the other 99% as tenants by the entireties by the married couple). It’ll be a joint tenancy with respect to the 99% and 1% and the 99% held by Mom and Dad as tenants by the entireties. I know — Strange.
Medicaid: Not countable for eligibility purposes and not available for estate recovery. The problem is, recall when someone sets up a life estate with real property they currently own in fee simple (or as tenancies by the entireties if owned by married parents) they are giving a remainder interest to others that is worth a certain percentage of the overall value of the property. That percentage value will be considered a Medicaid sanctioned transfer if there is a Medicaid application made within five years.
Example: If Falstaff is 70 years old, Medicaid uses an actuarial chart that shows Falstaff’s life estate to be worth about 60% of the value of the property, and Prince Hal’s remainder interest to be worth 40% of the property value. If the property is tax assessed at $100,000, Falstaff will be treated as having made a $40,000 sanctionable transfer, which could back to haunt him if he applies for Medicaid within five years. On the other hand, Falstaff could have sold Prince Hal the remainder interest and there would be no problem.
Another problem: If the land (or residence) subject to the life estate is sold, a portion of the proceeds will belong to the life tenant. In the example just given, Falstaff would receive 60% of the proceeds, which could be most inconvenient if he is on Medicaid.
Another planning strategy: One planning strategy that is occasionally used is for Falstaff to buy a life estate. Let’s say Prince Hal actually owns Blackacre. If Falstaff pays $60,000 for a life estate in Blackacre, he will pay fair market value so there will be no transfer penalty. Further, in North Carolina the life estate won’t be countable as an asset. But this DOES raise another issue.
The Issue: If the life estate Falstaff purchases is in property that was “the home of another person” (that is, this is Prince Hal’s home) then Falstaff would have to live in the property for at least 12 continuous months. If he doesn’t live there 12 months or more, there will be a transfer penalty on the purchase even though he may have paid fair market value. You can thank Congress for that little gem. On the other hand, if Blackacre is not “the home of another” Falstaff should be OK.
Taxes: If the property is sold and there are capital gains, a portion will be taxable to the life tenant and a portion will be taxable to the remainder interest holders. If it is the life tenant’s residence being sold, however, the life tenant will get a capital gains tax break on her share, but the life tenants – pay up! If the property is never sold, the remainder interest holders receive the property with stepped up basis to fair market value as of the date of the life tenant’s death.
Probate: Life estates avoid probate.
Lady Bird Deeds: These are sooo early 21st century! But because folks occasionally hear about these, I’ll explain. A Lady Bird deed looks like a standard life estate deed at first glance, except that the Grantor retains the right to change his mind or give the remainder interest to someone else. “I, Falstaff, give Backacre to Prince Hal, but I retain a life estate in Blackacre and further retain the right to cancel this deed or to give the remainder interest to any other person so named.”
Would you pay Falstaff money for the remainder interest? Of course, you wouldn’t. The remainder interest is worthless because Falstaff could always change his mind. On the other hand, if Falstaff dies without changing his mind, Prince Hal will automatically take Blackacre.
In North Carolina, because the remainder interest has no value Falstaff has not made a valuable transfer and there is no penalty. Further, on his death the property should pass free of estate recovery. Lady Bird deeds have worked fine for years. They do make me a bit nervous . . . they seem just . . . too easy. There is not a shred of law to support these. We at Mason Law, PC stopped using these years ago.
Instead, I prefer to use a 99% — 1% joint tenancy deed instead. At least you have the common law and an old North Carolina Supreme Court case to rely on.
A Final Word on Trusts
As you can see, the foregoing ownership techniques pose some Medicaid drawbacks. If there is any chance property could be sold, there is the problem with a portion of the proceeds being considered owned by the potential Medicaid recipient. Some techniques pose some potential estate recovery risk. If an individual feels like she can get through five years without applying for Medicaid (either because of good health or enough other assets to cover the nursing home bill for a few years), and if she cares about the property, a trust is usually a better asset protection technique. A trust can also preserve all the tax advantages discussed above.
Yes, a trust is a bit more complicated to setup. And yes, a trust is a bit more expensive. But in the grand scheme of things, it could well be a superior solution.
You can read more about trusts here. You can read more about Medicaid and Trusts here.
Monroe Pannell says
Bob good stuff as usual. I have printed copy and put in my Medicaid notebook that I have kept for years.
Regarding JTWROS-if Jr. dies first have we lost the benefit of the device? Or maybe Jr. and his sister Jane each buy a 1/2 percent JTWROS from mom and JR. dies first so Jr.’s family gets left out but sister Jane walks away with it all at mom’s death.
bob mason says
Correct, Monroe. Sister walks away with all. If she is nice she might share with Junior’s kids, but if she is not nice . . . . That’s yet another reason I tried to avoid JTWROS unless it is “late in the game” (someone is in, or about to go into, a nursing home) and I just can’t come up with any better alternatives.