by Bryan Woodford Esq.
An Irrevocable Trust is an Estate Planning document done most commonly for the purpose of protecting assets from the extremely high costs of a Nursing Home. An Irrevocable Trust, if done correctly and 5 years in advance of nursing home admission, enables the Grantor of the Trust to become eligible for MassHealth/Medicaid, while excluding the Trust assets. This type of Trust is more commonly appropriate for Elders over the age of 65. The Grantor creates a Trust for the benefit of others, most commonly their children or blood descendants, and sometimes charities.
The Grantor selects a Trustee(s) to manage the Trust Assets, and is often the Donor’s adult children. The Trustee holds title to real and/or personal property, as a fiduciary for the benefit of one or more named Beneficiaries, usually all of the Grantor’s children are equal beneficiaries. The Trustee must administer the Trust in accordance with the terms of the Trust, which is essentially a rule book created by the Grantor. The property transferred into the trust is then allocated and accounted for separately by principal and income, and then distributed as such, per the terms of the Trust to the beneficiaries. The trust is said to be irrevocable because the Grantor has no authority to modify or terminate the trust after its creation.
The Grantor(s) may retain rights to collect the income and interest generated by the principal, but keep in mind if those rights are retained and the Grantor enters a nursing home, then the income from the trust is counted towards the Grantor’s Countable Income in determining his or her share paid monthly to the Nursing Home as the PPA (Patient Payment Amount). The Grantor also has the option to have the asset protected from Medicaid, but retain certain control over the trust property, such as the right to change beneficiary within a certain class of people. This will allow the IRS to attribute the Trust Income and Tax liability towards the Grantor and not the Trust, which is beneficial because the Grantors tax bracket is usually lower than the tax brackets for Trusts. This is known for tax purposes as a Defective Grantor Trust. Additionally, assets transferred to the Trust are not treated as a sale, and gains are not recognized or realized at the time of the transfer. One negative aspect of Defective Grantor’s Trust is that for large estates, assets transferred to the trust are valued at the date of death, rather than the date of transfer, when determining if the Grantor’s estate is over the Federal and State Gift/Estate Tax limit or not.
Under Massachusetts Law, a life estate is the ownership of land for the duration of a person’s life. In legal terms, it is an estate in real property that ends at death, when ownership of the property may revert to the original owner, or it may pass to another person. The owner of a life estate is called a “life tenant” the person(s) that it passes to upon the death of the owner is called the “remaindermen”. In most cases I recommend the remainder interest to be held by a Trust so that it would not be susceptible to the remainder interest personal liabilities. The life estate is highly recommended for an elder to retain in the property so that they can never be legally evicted from their own property.
Life tenant, during his or her life, retains use and possession of the property, including the rights to rents and profits, and is also responsible for the costs of maintaining the property. The life tenant cannot sell or waste the property without the consent of the remainderman.
A common misconception is that the property cannot be sold while the Life Tenant is still alive, however that is not true. MassHealth and the IRS have a calculation to determine how much ownership interest both the life tenant and remaindermen have. For example, a 90-year-old life tenant selling property this month would be entitled to 13.36% from the sale while the remaindermen would receive the rest (or 86.64%). To calculate the value of the life estate yourself, you must first determine what the applicable interest rate is for the exact month the closing occurs. Practitioners typically use Tiger Tables Software to determine the applicable ownership percentage of the Life Tenant and Remainderman. It may not be economical for the common consumer to spend the money for the software, so it can also be calculated by;
- Finding the interest rate in the month of the sale (can be found at http://www.tigertables.com/7520.htm)
- Once you have this figure, you then go to IRS Book Aleph at (http://www.unclefed.com/IRS-Forms/2001/p1457.pdf) and look in Table S for the page displaying tables with that interest rate.
- Looking up the life tenant’s age on that page will get you the breakdown between the life tenant’s percentage interest in the proceeds and the other parties.
If the property is sold during the Life Tenant’s life, then capital gains tax would be due on any persons share that does not qualify for the Personal residence exemption (see IRS publication 523 as to qualifications for exemptions of capital gains tax. IRS Publication 523) However, if the property is not sold during the life tenant’s life, then upon their death the remaindermen receive a step up in basis for capital gains to the date of death of the Life Tenant.
These are very complex areas of Law, to set up a free consultation to discuss this further contact an experienced Elder Law Attorney such as Woodford Law P.C. email@example.com, 781-982-6093.
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