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Asset Transfer with a Retained Life Estate

Retaining a life estate in real property reduces the value of the transfer for Medicaid purposes and, since the penalty period is based upon the value of the asset that is transferred, this would accordingly change the penalty period.  Until September 2011, Medicaid could not place a lien on a life estate, unless the home were sold while the life estate holder was alive.  With recent Regulations, it appears that Medicaid will, in fact, be able to place a lien against a life estate.  We await further clarification on this issue. There are several advantages, as well as disadvantages, to transferring assets while reserving a life estate.  One advantage is to reduce capital gains upon the sale of the house after the death of the life estate owner.  If the homeowner were to sell the house before he died, he would incur a capital gains tax on the difference between his basis in the house and the sales price, less his $250,000 exclusion.  If he transfers the house outright, the recipient of the transfer would not have the same exclusion.  However, if he transfers the home while retaining a life estate, and the home were sold before he died, the recipient of the transfer, called the remainderman, would incur capital gains tax on the remainder interest.  The life estate owner would be able to offset his capital gains on the life estate portion with his $250,000 exclusion (but only up to the value of the life estate).  If the house is retained until his death, the remainderman gets the benefit of a step-up in basis, thereby reducing any capital gains liability upon sale. There are some disadvantages to retaining a life estate. If the house is sold before the life estate owner’s death, the remainderman will incur capital gains and the life estate owner may not be able to utilize the full $250,000 tax exemption.  Further, if the life estate owner is in a nursing home, a portion of the sales proceeds are payable to him, and, therefore, they will be available to the nursing home to pay for his care.  Also, if there is no sale, the remainderman essentially becomes a landlord.  If the house is rented, the net rental income will go to the nursing home to offset his expenses.  Another potential disadvantage is a Medicaid lien. To receive a free copy of A Simple Guide to Understanding the Complexities of Elder Law – a helpful booklet we distribute to our clients which contains definitions and explanations of some important terms – please contact us.