The Elder Law Minute: The truth about irrevocable trusts

August 12, 2014 Ronald A. Fattoullah, ESQ. and Debby Rosenfeld, ESQ.
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Trusts are commonly used in Medicaid planning, but it is important to note that they are not “one size fits all.” Trusts are not needed in every situation, and different trusts are useful for different purposes. Utilizing an irrevocable trust is one of several ways to protect and preserve a client’s assets.

Unfortunately, many seniors attempt to engage in the dangerous practice of DIY (do-it-yourself) Medicaid planning. Often, a senior will transfer assets to a child without considering all the ramifications. Medicaid planning with an experienced attorney will involve careful consideration of many complex issues.

When properly drafted, an irrevocable trust used in Medicaid planning will not only protect assets but will preserve capital gains tax benefits and avoid probate. The following are some of the benefits of using an irrevocable trust:

•Ensuring the senior’s right to continue to live in his/her own home: A valuable benefit of an irrevocable trust is the ability to reserve the right of the senior to continue to reside in his or her own home after the home is transferred out of such individual’s name.

•Preserving capital gains tax benefit: Capital gains tax is the tax paid on the appreciation in value of an asset once it is sold. For example, if a father purchased a house for $50,000 (cost basis) and later sells the house for $600,000, he will be taxed on the $550,000 of gain. The father is entitled to a $250,000 capital gains tax exclusion if he resided in the house for at least two of the previous five years. However, there will still be taxable gain on the remaining $300,000 ($550,000 of gain less exclusion of $250,000 leaves $300,000 of gain).

Further, if the father gifts the property outright to his children during his lifetime, their cost basis in the house will be the same as their father’s — $50,000 — and they will recognize a significant capital gains tax upon the sale of the house without benefiting from any $250,000 capital gains tax exclusion.

Nonetheless, if the same individual keeps the house until he dies, his children will benefit from a “step-up” in the cost basis to the value of the house at the time of their father’s death. If the house is sold for $600,000 after the father dies, the children will not be subjected to any capital gains tax, because their basis will no longer be what their father paid for the house (i.e., $50,000), but rather what the house was worth when he died.

If the father were to transfer his house during his lifetime to an irrevocable trust, the ultimate beneficiaries would avoid or minimize capital gains taxes in most instances. And, Medicaid will not count the house held by a properly drafted irrevocable trust as part of the applicant’s assets.

For example, if the trust holds the father’s house until he dies, the children will get a complete step up in basis upon his demise. That means that if the house is sold for $600,000 by the trust after the father dies, there will be no capital gains tax imposed. Furthermore, if the house is transferred to the trust and is sold by the trustee during the father’s lifetime, the $250,000 capital gains tax exclusion will be applied (provided certain language is incorporated into the trust).

•Preserving property tax exemptions: Many seniors and veterans are able to afford to live in their homes because of the property tax exemptions they receive. Transferring a house outright to another person will cause a senior to lose property tax exemptions and a veteran to lose his or her veteran exemptions. Transferring a house into an irrevocable trust will preserve property tax exemptions because the senior or veteran reserves sufficient rights in the home so that he or she can still qualify for such exemptions.

•Protecting against financial problems of beneficiaries: Transferring assets outright to beneficiaries with financial problems does not achieve the goal of most seniors who wish to preserve and protect their hard-earned assets. In cases where it is not prudent to transfer assets to a beneficiary who has a creditor issue or spending problems, an irrevocable trust is a great way to preserve and protect assets for Medicaid planning.

•Avoiding Probate: Assets held in a trust, including an irrevocable trust, will not require the probate process (court process) in order for the beneficiaries to gain access to the assets upon a senior’s death.

Some seniors do not like the idea of an irrevocable trust because they feel control is being taken away from them. However, it is important to know that while much of the control over the assets in an irrevocable trust will be given to the trustee, there are several important powers reserved. All income, such as interest and dividends, can continue to be paid to the senior. The senior retains the right to live in the home transferred into the trust. The senior can also have the right to change the beneficiaries of the trust, with some limitations.

An irrevocable trust is a commonly used and effective tool in Medicaid planning, however, it is not the right tool for everyone. Therefore, it is crucial to consult with an attorney who will conduct an in depth assessment of the case and tailor the recommendations based on that assessment.

Ronald A. Fatoullah, Esq. is the principal of Ronald Fatoullah & Associates, a law firm that exclusively concentrates in elder law, estate planning, Medicaid planning, guardianships, estate administration, trusts, wills, and real estate. Yan Lian Kuang-Maoga, Esq. is an elder law attorney at the firm. The law firm can be reached at 718-261-1700, 516-466-4422, or toll free at 1-877-ELDER-LAW or 1-877-ESTATES. Mr. Fatoullah is also the co-founder of JR Wealth Advisors, LLC. The wealth management firm can be reached at 516-466-3300 or 800-353-3775.

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