Common Strategies to Protect the Home from Medicaid Recovery
May 14, 2018 | by the National Care Planning Council
In a previous article we addressed the state Medicaid recovery programs and how they typically go after the only remaining asset which is the home. In this article we will discuss some of the strategies that can be used to protect the home from Medicaid estate recovery. There are a number of strategies that can be used. In those states that go after probate property only, anything that keeps the house out of probate will suffice. In other states, some common strategies include the use of irrevocable trusts or transfers before death.
Most of these strategies involve giving away ownership of the home. This creates a penalty either for a potential Medicaid application or for someone already on Medicaid whose name was on the property. There are also a number of strategies to deal with this penalty. The reason for creating a penalty through an outright gift or a trust is to start the five-year look back. Another reason might be to get the property out of the name of an aid and attendance applicant.
Transfer of the property as a gift, thereby creating a penalty, can be reversed in almost every state. In other words, if the consequences of a Medicaid penalty outweigh the advantages of gifting the property, the title is changed back into the name of the Medicaid beneficiary in order to allow that person to receive Medicaid benefits. In case the Medicaid beneficiary is incapacitated, a proper durable power of attorney that includes gifting rights must be set up in advance while the person was competent to do this.
Sell the House and Use Half a Loaf
Selling the house is generally only an option if a spouse or another member of the family does not need to live there. Selling the house might be an option for a single Medicaid beneficiary. Selling the home should be weighed against keeping the home as an exempt assets due to the Medicaid beneficiary signing an intent to return. The amount of recovery against the house depends on how much Medicaid has to pay for the beneficiary. If this is a sizable monthly amount it could add up quickly. Under these circumstances, over a period of a year or two, recovery could eat up the value of the home. If this is the case, the possibility of selling the home sometime prior to applying for Medicaid or shortly after applying for Medicaid should be considered. If the Medicaid obligation is not significant, perhaps the family could be satisfied with a recovery against the home.
Funds from the sale of the home will disqualify the Medicaid beneficiary until he or she has spent down to less than $2,000. However, a half a loaf gifting strategy could be used to transfer approximately 50% of the funds to someone else. This strategy might make sense for these reasons.
- Anticipated recovery against the house -- which is currently exempt -- will eat up its entire value fairly quickly
- Selling the home while the owner is alive takes advantage of the capital gains exclusion and reduces or eliminates the taxes owed on capital gains
Medicaid Recovery Where the Community Spouse Outlives the Nursing Home Spouse
In many states, if the community spouse is alive after the Medicaid beneficiary dies, the state will not attempt recovery even after the death of the community spouse. The home is always protected from recovery as long as the community spouse is alive whether he or she lives in the home or not.
In those states that attempt recovery, the community spouse, if healthy, can employ a number of gifting strategies. This is because Medicaid in these particular states cannot apply a lien against the house while the community spouse is alive and living in the home. This does not mean that if the state is entitled to recovery, it cannot pursue civil action. Whether this happens on a regular basis we don't know.
When the Nursing Home Spouse Outlives the Community Spouse
If the community spouse dies prior to the nursing home spouse, under state intestate laws, the nursing home spouse will inherit the home. If the home is solely in the name of the community spouse, then the home is not considered a personal residence by the nursing home spouse and the home is no longer exempt and will count as an asset. This will disqualify the nursing home spouse for Medicaid.
An attempt could be made where the home is solely in the name of the community spouse to create a will that disinherits the nursing home spouse. Unfortunately, states do not allow spouses to disinherit each other and require that regardless of any prior arrangements, a surviving spouse has a legal right to an "elective share" of the assets. In some states, this could be a third of the amount or possibly one half of the amount or some other number.
There is also a problem in those states where the community spouse transfers the home to someone else and that counts as a disqualifying gift for the nursing home spouse. Thus any gifting arrangements prior to death would disqualify the Medicaid beneficiary.
An immediate and sudden death of the community spouse cannot be planned for. An anticipated death, due to declining health, can be planned for. Strategies for dealing with this potential problem need to be addressed by a qualified elder law attorney.
Avoiding Recovery in Probate Only States
In those 13 states that only apply recovery through the probate process, any planning strategies that bypass probate will prevent recovery. This might include the use of a living trust or putting other people on the title in joint ownership with rights of survivorship.
It should be noted that if the state changes its definition of "estate" to include trusts, life estates or other arrangements, there has been typically no grandfathering allowing application of the previous rules. In other words, if the planning has been done to avoid probate and the state can now go beyond probate for recovery, little can be done to avoid this.
Irrevocable Trusts for Avoiding Medicaid Recovery
A properly structured irrevocable trust, meeting Medicaid requirements, that has title to the home, will avoid recovery. The problem is that transferring the home to the trust will create a penalty within the five-year period from the date of transferring title. The exception to this is in those states where the community spouse has sole title to the property and can transfer the home without affecting the eligibility of the nursing home spouse. On the other hand, the transfer of the property does create a penalty for the community spouse.
Promissory Note for Medicaid Recovery
The home could be sold on a promissory note and this effectively changes it from an asset to a loan and it is no longer considered an impediment to Medicaid qualification. Payments from the loan must be used to offset the care cost of the Medicaid beneficiary. This strategy used to be a very common one prior to the Deficit Reduction Act. The new rules pertaining to promissory notes make this strategy much more limited.
The term of the loan cannot exceed the life expectancy of the Medicaid beneficiary. For example, for a 90-year-old this might only be five years. This would make the payments very large and potentially unattractive for the family who is buying the property. All payments through the life of the loan must be equal. In addition, the loan cannot be canceled at death but payments must continue throughout the term of the loan into the estate of the deceased beneficiary which would make them subject to recovery. In those states that use probate for recovery, Medicaid could be bypassed by naming a beneficiary of the loan payments other than the state. The loan must be non-assignable meaning it cannot be used as collateral for another loan or purchased outright for cash.
The Ladybird Deed
This is a very clever way to transfer ownership in the property without creating a gift and a penalty. This deed is not available in all states but works very well in the states that allow it. The concept is quite simple. The deed transfers ownership of the property at the death of the Medicaid recipient. Any transfer of the home by a Medicaid beneficiary or by the spouse of that beneficiary, while that beneficiary is alive, will create a penalty. In this case, the transfer creates a penalty as well. But because it is at the death of the Medicaid recipient, it is irrelevant that a penalty is assessed. The deed retains ownership in the home for the Medicaid beneficiary and as such it is not considered a gift and no penalty is assessed by creating a ladybird deed.
Preserving Tax Breaks for Home Ownership if Title to the Property Is Changed
Gifting a personal residence prior to death or to sale by an owner who has resided in the home for at least two of the last five years results in a loss of significant tax breaks. If the personal residence is sold while the owners are alive, a lifetime capital gains exclusion of $250,000 for a single individual or $500,000 for a couple applies to the sale. Thus, if a portion of the exclusion has not been used previously, either $250,000 worth of equity or $500,000 is excluded from capital gains taxes of 15%. As an example suppose that a couple has established a basis in their home of $50,000 based on their original purchase price plus improvements and adjustment of any depreciation claimed for business use. Suppose that the home sells for $400,000. Without the capital gains exclusion, the couple would have to pay a capital gains tax of 15% of the difference between their basis and the selling price -- $350,000. This amounts to $52,500 in taxes. With the couples' exclusion there is no tax.
There is also tax relief if the children inherit the property at death. Instead of inheriting the basis in the property, the children will inherit the sale value of the property at the time of death. This is called the step up in basis and depending on when the property is sold, there is little if any capital gains tax due.
Any gifting strategies for the personal residence discussed in this manual, require a change in the title and this constitutes a gift to those persons on the title. Those persons receiving their portion of the value of the property by a gift lose the capital gains exclusion, unless they can establish personal residence by residing in the property for two of the forthcoming five years after their name is on the title. They also lose the step up in basis if they choose to sell the property outright.
The IRS recognizes certain irrevocable trusts called "grantor" trusts that if structured properly, can retain the capital gains exclusion and the step up in basis even though ownership has changed to the trust. We will discuss these arrangements in much more detail in the section on taxes.
The "Due on Sale Clause" if Title Is Changed
The due on sale clause was instituted in the beginning of the 1980s to protect banks from loan assumptions that could possibly preserve existing interest rates which were lower than prevailing rates. The banks didn't want to be stuck with an assumption with lower interest loans as interest on new loans was increasing substantially. Initially, there was no legal enforcement other than tort enforcement for the banks. A Supreme Court case in 1982 and a subsequent statute passed by Congress in the same year gave Federal legal stature to this provision. Here is the clause as typically written into every mortgage contract.
Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument. If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is delivered or mailed within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.
This provision creates a problem for transferring title in the home when there is an existing mortgage lien on the home. It is becoming more common nowadays for seniors to borrow against the equity in their homes because many seniors don't have the income otherwise to pay their bills. The most common types of loans are home equity lines of credit or reverse mortgages. But, we are also seeing more and more seniors refinancing their homes outright to get at the equity.
Transferring the home into a trust or even retitling it requires permission from the mortgage company or bank. By the way, FHA and VA loans do not have these provisions but they do have a requirement that anyone assuming the loan must go through a credit check and be approved prior to allowing the assumption. Living trusts are specifically excluded from this provision and can be used as a way of shifting the title. Unfortunately, living trusts are of little value in the type of planning that we do for Medicaid or VA benefits.
If there is a mortgage lien on the property, this may prevent implementing some of the strategies that we have discussed. On the other hand, as long as the original titleholders names remain on the property, there should be no reason to prevent putting other names on there as well. However, the clause does require permission, even for a partial transfer of interest in the property.
In some cases, triggering the due on sale clause might be an acceptable practice for certain strategies. It is not illegal to trigger the clause, it only gives the mortgage holder the right to demand full payment or eventually foreclose. If the primary residence is going to be left vacant, and the intent is to sell, then triggering the clause might be the lesser of two evils in the planning process. If the sale were agreed to prior to transferring the property to a trust, the seller has 30 days before the bank can take any action. On the other hand, if the housing market is not good and it takes too long to make the sale, foreclosure could happen and that might be a worse consequence. In addition, transfer of the title to a trust might also affect the title insurance filed with the mortgage company.
Then there is the case of reverse mortgages. If there is a reverse mortgage on the property, when the property is vacated by the original individuals on the mortgage, the loan becomes due anyway. Oftentimes, the bank is willing to wait for 12 months in order to get the property sold. We are not sure what the consequences on a reverse mortgage are of transferring the title to an irrevocable trust when the house is left vacant as opposed to the procedure the bank goes through to call the loan when the provisions of the reverse mortgage are no longer met.