You may have heard the term “estate recovery” before and wondered what it meant. This is a process that can occur after a Medicaid recipient dies. Their state may attempt to recoup from the deceased person’s estate whatever benefits it had paid for their care. For most Medicaid recipients, their house is the only asset available.
However, there are steps you can take in an effort to protect your home.
For many people, setting up a "life estate" is the simplest, most appropriate alternative for protecting their home from estate recovery.
What Is a Life Estate?
A life estate is a form of joint ownership of property between two or more people. Each party has an ownership interest in the property, but for different periods of time.
The person holding the life estate possesses the property during their lifetime. The other owner(s) has a current ownership interest. However, they cannot take possession until the end of the life estate. The end of the life estate occurs when the life estate holder dies.
For example, Jane gives a remainder interest in her house to her children, Robert and Mary. Jane retains a life interest for herself. She carries this out through a simple deed. Thereafter, Jane has the right to live in the property or rent it out, collecting the rent for herself.
As the life estate holder, Jane is responsible for the costs of maintenance and taxes on the property. Yet she can’t sell the property to a third party unless Robert and Mary, the remainder interest holders, cooperate.
The house will not go through probate when Jane dies. At her death, the ownership of the home will pass automatically to the holders of the remainder interest, Robert and Mary. Although the property will not be part of Jane's probate estate, it will be part of her taxable estate.
Depending on the size of Jane’s estate and her state's estate tax threshold, the property may be subject to estate taxation. However, this can mean a significantly reduced capital gains tax when Robert and Mary sell the property. This is because they will receive a "step up" in the property's basis. (Learn more about “step up in basis” and why it matters in estate planning.)
Be Aware of Medicaid Payback Rules
Let’s imagine that you decide to transfer the deed to your home to your children while retaining a life estate. You could end up triggering a period of up to five years during which you would not qualify for Medicaid. (Get more information about how this Medicaid look-back period works.)
Purchasing a life estate in another home can also cause a transfer penalty. However, you may be able to avoid this transfer penalty if you were to meet the following conditions:
- you purchased the life estate,
- you resided in the home for at least one year after the purchase, and
- you paid a fair amount for the life estate.
To create a life estate, you would execute a deed that conveys the remainder interest in the house to another party while you retain a life interest. In many states, once the house passes to the remainder beneficiaries, the state cannot recover against it for any Medicaid expenses that the life estate holder may have incurred.
Transferring Your Home to an Irrevocable Trust
Another method of protecting the home from estate recovery is to transfer it to an irrevocable trust. Trusts provide more flexibility than life estates but are somewhat more complicated. (Learn more about some of the most common kinds of trusts.)
Once you have put your house in this type of trust, you cannot take it out again. Although you can sell the house, the proceeds must remain in the trust. This can help protect more of the value of the house if it is sold.
With a properly drafted trust, the later sale of the home while it is in this trust might allow the settlor, if they had met the residency requirements, to exclude up to $250,000 in taxable gain. If the owner had transferred the home outside of trust to a non-resident child or other third party before the sale of the house, this exclusion would not be available.
To learn more about life estates and Medicaid estate recovery, check out the following articles: