Contra Costa Elder Law Blog
authored by F. Michael Hanson, Attorney at Law
Covering the Gamut of Elder Law and Related Estate Planning Issues
Again, for purposes of illustration in this last segment, assume the following background facts:
The Fourth Reason Not to Transfer the Home - Avoiding Capital Gains Taxes at My Father's Death.
Assume my father transferred the home to me, and he later passes away. If I decide to sell the home after his death, I will suffer large capital gains taxes on the sale calculated as follows:Gross proceeds: $816,000
Again, for purposes of illustration in this four-part series, assume the following background facts:
The Third Reason Not to Transfer the Home - My Father Should Have Access to the Entire Value of the Property.
My father might actually want access to the equity value of his home to pay for in-home care services - so he can stay at home and not be forced into a skilled nursing facility, or any other type of care facility, earlier than necessary. The equity value in his home could be obtained for this purpose in a variety of ways:(a) a Credit Line or Refinance Loan on the home could be acquired, and thereby cash obtained, so he would have more money available to pay for his own care at home. My father may not need in-home or other care services yet, but we should not deprive him of this equity-access option.
If my father did need care services at home, and care services were being provided, it is true that there would be "double payments" in this scenario: (1) payments to the care-givers on the one hand, and, (2) loan payments on the credit line or mortgage on the ohter. And although this option seems a wasteful use of his equity, it is still wise to keep it "on the table". Why? Because my father has no interest in entering a nursing facility, or going anywhere else, earlier than necessary. Although it may seem "smart" to transfer the home now, later, and in hindsight this may not appear to have been such a good idea - my father will likely wish he still had this option available - to at least consider.
And where it is true that I could, when the time came, transfer the home back to my father, for such loan purposes, title companies and lenders will be less likely to approve a loan on property which has been "trading-hands" between us lately. It arouses, in their minds, worries about possible creditors or liability problems which my father and I are attempting to avoid; in short, transfers back and forth compromise the probability of loan approval.
(b) Although a Reverse Mortgage on a home is typically viewed as an unfavorable option, it could be timely obtained to assist my father with his care. A reverse mortgage could generate a significant amount of cash to assist in the payment of (if necessary) in-home care services for my father. An FHA reverse mortgage, also called a Home Equity Conversion Mortgage (or HECM), could generate as much as a $389,000 advance (in the case of my father and his property) and unlike conventional loan financing, no credit or income qualifications are necessary to obtain a reverse mortgage (you might want to check this AARP link to enter the relevant data about elder adult(s) whom you think might find such an arrangement beneficial for in-home care purposes or other living expenses).
And the possibilities here are significant. As part of President Obama's stimulus program, Congress recently raised the HECM loan limit from $417,000 to $625,500! (though this higher loan limit may expire at the end of this year if Congress does not grant an extension to the program).
With a reverse mortgage no monthly payments need be made to the lender, and the loan need not be repaid so long as the elder (or elders, or the survivor of them) continues to own and occupy the home as his or her residence. See this federal FHA site as well, for more information on the terms and conditions under which these federal supervised reverse mortgages are available.
There are, admittedly, considerable costs and other conditions which accompany an FHA reverse mortgage arrangement, and they should be examined very carefully (and you'll also want to make sure that the reverse mortgage arrangement is not accompanied by, or followed-up by an investment advisor who pressures the elder adult into purchasing an annuity or some other "exotic" investment with the reverse mortgage proceeds) but the point is: transferring my father's property out to me at this time would be equivalent to taking the reverse mortgage option "off the table" as well.
Now, in the case of a reverse mortgage, I could transfer the property back to my father, because there is no minimum period of ownership required in order for him to be eligible for a reverse mortgage. But considering the other risks which could endanger the property (described in Part One of this series) and the tax consequences of an early transfer (described further below), why should he transfer the property to me at all?
Side Note: I do not sell or sponsor the sale of reverse mortgages. And I typically consider the reverse mortgage option conservatively, mostly as a "last resort" to any long term care planning approach. However, reverse mortgages do have a place in long term care planning, and I do appreciate the benefits which an FHA reverse mortgage can offer disabled elder adults, that being, quite simply, cash - cash which can help them with living expenses and, more importantly, keep them at home, even if just a little longer.
(c) Selling the Home Can Create Cash, But if I Own the Home There Will be Excessive Income Taxes. Selling my father' s home can generate useful cash, but there will be significantly higher income taxes on that sale if the home is owned by me rather than my father.
Such a sale might be necessary - because the transfer of my father's home to me triggered a Medi-Cal ineligibility period (See Part Two of this Series - and I haven't retained a elder law attorney to help me undo that mistake) - or because a sale of the home seems favorable in order to generate cash to pay for my father's care in an assisted living or board and care facility (since he only has $12,000 of available cash to pay for such care).
In any event, if my father's home is to be sold for such purposes, it would be better if the home were still in his name, and not mine. If title to the property remained in my father's name, he can take advantage of the $250,000 residential income tax gain exclusion on the sale of his home (because he has both "owned and used" the home as his principal residence for at least 2 out of the last 5 years). Under these circumstances, taxes on the sale of his home (assuming he received sales proceeds of $816,000) would be:
Gross proceeds: $816,000
Less: basis (his purchase price) -$16,000
Less: the exclusion -$250,000
Taxable proceeds: $550,000
Capital gains taxes: $133,650 (net proceeds retained: $682,350)
(taxes calculated assuming combined State and federal rates of 24.3%)
However, if I own the property and sell it for my father's benefit, I do not qualify for that $250,000 exclusion. Therefore, taxes on the sale would look like this:
Gross proceeds: $816,000
Less: basis (his purchase price) -$16,000
Less: the exclusion (none) -$ -0 - (I am not eligibile for this exclusion)
Taxable proceeds: $800,000
Capital gains taxes: $194,400 (net proceeds retained: $621,600)
(again, taxes calculated assuming combined State and federal rates of 24.3%)
As you can probably see... the result of transferring my father's home to me, and then my selling it, creates an additonal $60,750 in income taxes payable to the State and federal government.
Can I transfer the property back to my father and have him sell the property in his name? Yes, unless the transfer back to him occurs any later than 3 years after he transferred the property to me. If the transfer is made any later than 3 years after his initial transfer to me, he cannot claim the $250,000 exclusion because he will not be able to state that he has both "owned and used" the property "2 out of the last 5 years" (it would be something less than 2 years - because, despite his continued "use", I owned the property in my name for more than the last 3 years). So the damage can be reversed if the problem is detected early enough, but if I forget about this 3-year limitation sometime after his transfer of the property to me, and 3 years pass, the tax loss is permanent.
Transferring the Home Between Us Can Create Unexpected and Damaging Gift Taxes. Consider, also, the following gift tax nightmare scenario: I transfer the property back to my father so he can acquire a loan, or a reverse mortgage on the property, or so he can sell it and avoid the excess income taxes. And then, later, he determines, that he wants to gift transfer the home (or the remaining proceeds of the sale) back to me anyway - because skilled nursing care seems certain at a later point in time. Aside from the Medi-Cal ineligibility which would result from this secondary transfer, there would also be an unexpected and devastating gift tax on the second transfer of the same property (or its proceeds).
Though the federal estate tax exclusion on the death of a person is currently set at $3, 500,000, the lifetime gift-tax exclusion is limited to $1,000,000. At the point where the total value of the gift-transfers my father has made to me exceeds $1,000,000, the excess value transferred incurs a gift tax, and at the rate of 45%.
The first gift-transfer of my father's $816,000 residence to me uses-up $803,000 of his available $1,000,000 lifetime gift tax exclusion (a $13,000 per person annual gift exclusion would be applicable to this gift-transfer and not be counted against the lifetime exclusion number, hence only $803,000 of the $1,000,000 exclusion is used-up). As a result, and as to all future gifts made by my father, there is only $197,000 of the lifetime gift tax exclusion remaining. Therefore, if my father were to transfer his home to me "again" there would be huge gift taxes payable.
For instance, assume I transfer the home back to my father so he can obtain a reverse mortgage on the home, and that he does qualify for and receives a reverse mortgage and $389,000 of loan proceeds. This would leave the home with a net value of only $427,000. When he transfers that net-valued $427,000 home to me, it will create a payable gift tax of $97,650! ($427,000 transferred, less the remaining gift exclusion of $197,000, and less another $13,000 annual exclusion (if applicable), leaves $217,000 of a taxable gift; and at a 45% rate, this creates payable gift taxes of $97,650).
First of all, assume the same facts as before, but focus on the following facts: (1) that the home has an assessed value of $160,000, and (2) that the home is still in my name (rather than my father's ) as a result of his early transfer of the home to me.
The Second Reason Not to Transfer the Home: Such a Transfer Could Create Ineligibility for Medi-Cal Coverage if the Elder Adult Should Actually Need Nursing Home Medi-Cal Benefits Anytime Soon.
If it is conceivable that my father will have to enter a skilled nursing facility in the near future, the transfer of his home will, after a Medi-Cal "look-back" analysis of that transfer, create a period of ineligibility - a period of time during which my father will not be entitled to receive nursing home Medi-Cal benefits but will instead have to use his own assets to pay for his nursing care.
More specifically in this case, the Medi-Cal personnel will calculate the period of ineligibility by taking the $160,000 assessed value of the home (not the fair market value of the home, thankfully - just the assessed value) and dividing that value by $5,698 (the APPR figure for 2009). The result of this analysis will be 28 months of Medi-Cal ineligibility ($160,000/$5,698 = 28.08).
Where it is true that a residence is considered an "exempt" asset in a Medi-Cal eligibility context, that "exempt" status exists only if my father has the legal right to occupy the home (and can claim on the Medi-Cal application that he intends to return home). If my father, has, however, transferred full ownership of his home to me, he no longer has a legal right to occupy the home, and therefore cannot claim the applicable exemption. As a result, the home will not be "exempt", but instead subjected to the look-back transfer and ineligibility penalties described above.
This result would force me to sell my father's home to pay for the 28 months of nursing care which Medi-Cal will not cover - and this sale would cause unhappy income tax consequneces.
See Part Three of this series which includes a discussion of the damaging income tax consequences which attend a child's ownership and sale of the elder adult's home.
Often when an individual elder adult has suffered his (or her) first minor stroke, or has received an early diagnosis of dementia or some other debilitating disease, the children (even the elder himself) will decide to "take action" - because the threat of huge, inevitable nursing home expenses, followed perhaps by a State's "lien", seems certain.
And the action taken is frequently an immediate deed-transfer of the elder's home to one or more of the elder's children. The belief is that the home is "safer" in the children's hands, away from the reach of the "system", and, if necessary, the home can still be sold by the child(ren) to pay for the elder's care.
However, this typical “knee-jerk reaction” transfer is a critical error which creates more risks and damage than the protection it is intended to accomplish.
First of all, for purposes of illustration in this four-part series, let's assume the following background facts:
The First Reason Not to Transfer the Home: Despite the Child’s Good Intentions, the Home Could be Lost to Misfortune.
My father's home, now in my hands, is at considerable risk - not because he can't trust me, but because Murphy's Law and just "bad luck" are forever busy.
For instance, what if I were to suffer some major injury which wasn't totally covered by medical insurance, and as a result of the huge medical debts (or other bills I couldn't pay because I was out of work, recuperating, for a month or more), I had to file for bankruptcy? Because I (rather than my father) now own the home, the bankruptcy trustee would be force-selling the home to satisfy my creditors' claims - and my father would be "on the street".
What if I were to run-down Rush Limbaugh (or some other commentator or politician) in a cross-walk for whom no insurance was enough money, and I was consequently sued in a ridiculously large lawsuit.... or just some other lawsuit..... and my insurance was insufficient (or I had none) to handle the resulting judgment against me? Again, because I now own the home (rather than my father), my judgment creditors would be placing their judgment liens on, and force-selling, my father's home to satisfy their judgments - and my father would be "on the street".
What if I was "so sure" that ... if I just obtained a modest loan on the home... and I just invested the loan proceeds through my Scottrade account in, let's say, "sure thing" investments like Lehman Brother's stock, or Washington Mutual stock, or with Bernard L. Madoff''s Investment Securities, LLC, - and I was mistaken, and the investment became worthless... or just worth less? A sizable portion of my father's equity in the property is lost...
What if I unexpectedly predecease my father (driving home on our local 680 freeway these days is like "running with the bulls"... and almost as hazardous). At my death my estate, which includes my father's property, would be left to..... whom??
There are more examples, but this should be sufficient to make the point. My father should keep the ownership of his home in his own name. In my hands, and despite my best intentions, I cannot guarantee his home will always be there for him.
Important Side Note: I often remind clients that the State of California does not develop rights against a person's home simply because that person "might" need nursing home care in the future. The State does not impose any pre-nursing-home liens or claims against a person's home or other assets. A person's home does not become an immediate target upon his first broken hip or an arguable case of dementia. Quite to the contrary (and it is very important to remember this) the State has no claim to any property of a person until it spends at least "dollar one" on that person's care through the Medi-Cal system (and note that I am here referring to the Medi-Cal system, not the MediCare system - you need not worry about Medicare expenditures - neither the State nor federal government attempts to recover for Medicare benefits paid). Moreover, should the State of California start spending money on a person's care through the Medi-Cal system, it can only later recover the amount of money it actually spent on that person's care. The State is not entitled to a "windfall"; it can not lay a claim to a person's entire home or assets simply because that person began receiving Medi-Cal benefits. And then again, with proper estate planning, that potential "recovery" can often be entirely eliminated.
With an updated and properly structured durable power of attorney, one which authorizes specific gifts of real property and other assets in the event of permanent nursing care, my father can continue to keep his home and other assets securely in his own name, and still empower me to transfer his home, cash, investments, etc. - if the need later arises.
So don't transfer your home prematurely. Instead update your estate plan documents with my assistance, or with the assistance of another experienced elder law and Medi-Cal planning attorney. Your home is the most valuable asset you own. Don't make a risky, haphazard transfer of it.
See Part Two - Medi-Cal ineligibility which a transfer of the home will create.
Anyway... if included in the final House and Senate version of the health care reform bill, this CLASS Act will create a voluntary program through which Americans can pay a monthly premium to the government, estimated to be, initially, around $65 per month. In return, and if the person paying these premiums has contributed to the program for at least five years, and is in need of long-term care assistance, he or she will be eligible for a modest benefit to help pay for a certain services related to the degree of disability being suffered. The idea is to assist the contributor to stay in his or her home. In the House bill, this benefit would depend on the degree of incapacity, but estimates indicate it would average about $50 a day.
(By the way, the Senate's version of this program, similar in its concept, is a creature of their Health, Education, Labor and Pensions committee - the "HELP" committee (sounds good, doesn't it?)).
At this point it is unclear which version of the CLASS Act, or what blended House and Senate version, will be incorporated into the final health care reform bill (if a final bill is passed at all), but the CLASS Act has one huge advantage that could ensure its survival: it will be, at least initially, a revenue generator for a few decades. In its preliminary analysis of the House bill, the Congressional Budget Office projected that because the CLASS Act would pay out far less in benefits than it would receive in premiums over a 10-year budget window, it would reduce deficits by about $72 billion, and by a smaller amount in the following decade.
After 2029, however, the program will start contributing to the federal deficit, but by a comparatively small amount compared to other provisions of the health care reform bill.
As currently structured in the House bill, this program offers between two and six different benefit levels, depending on level of the contributor's disability. The House version indicates there will be a sliding scale of benefits, ranging from, say, $30 a day for inability to perform two "activities of daily living" (ADLs) to a benefit of $70 a day for five or six ADLs. Under the House version, enrollees have to be working when they first enroll, but can quit a job after they sign up and still be in the program.
The insurance industry is lobbying to remove the CLASS Act from health reform legislation, arguing that its modest benefit will not adequately protect Americans who need nursing home care or 24-hour home health care services. A survey by the American Council of Life Insurers, which is spearheading the opposition to the Act, found that public support for the CLASS Act drops when respondents learn about its potential cost. The survey found that only 3 percent of respondents would participate in the program if premiums reached $160 monthly, which is the level the American Academy of Actuaries-Society of Actuaries argues will be required for the program to remain solvent.
Frankly, I do not believe these results reflect a fair survey of potential enrollees. If you keep increasing a sample or "test" premium you can discourage 97% of any group of survey respondents - it's just a question of amount. And the $160 per month solvency benchmark isn't particularly persuasive. I do not recall the lack of solvency as ever dissuading Congress from a proposed course of action. So using a $160 amount as a sample premium is, at best, specious.
I wonder if the survey participants were apprised of the total picture. For instance, if I was allowed the opportunity to pay $65 per month for a minimum of five years (a total of $3,900), or even $160 per month for five years (a total of $9,600)(neither of these monthly payments is even near your standard car payment these days), and I knew that my contributions would eventually afford me an average of $50 per day of assistance in the event of a disability (this would be $18,250 of benefits in just the first year alone!), I would see a definite value. To be certain, the benefits are modest, but even a little help can make the difference between home... and a nursing home.
Actually, this program does "sound good".
Here in California this means that the Community Spouse Resource Allowance (CSRA) now set at $109,560, will remain the same for the year 2010. The spousal monthly income allocation (also called the Minimum Monthly Maintenance Needs allowance, or MMMNA) which is now set at $2,739 per month, will also remain the same throughout 2010.
Are these numbers important? Yes!
If one spouse is admitted to a skilled nursing facility, the other spouse at home (which the Medi-Cal program refers to as the "community spouse") should be careful not to needlessly liquidate and "over-spend" assets before requesting Medi-Cal coverage for his or her ill spouse's care. Some folks believe that the at-home spouse must spend available assets down to just $2,000 before attempting to qualify for nursing home Medi-Cal. This is not correct. In addition to those assets which are "exempt" under Medi-Cal (i.e. the home, a car, IRA's, retirement accounts, etc.) the spouse at home can also retain an additional $109,560 worth of any non-exempt assets, and still obtain Medi-Cal benefits for his or her institutionalized spouse. The CSRA is like a $109,560 protective "wild-card" which can be applied to shelter additional non-exempt assets which the couple owns. They need not spend their assets down to a meager $2,000. In some cases this $109,560 CSRA figure can be increased to protect an even larger amount of non-exempt assets.
The MMMNA (spousal income allowance):
Once Medi-Cal eligibility is obtained for the institutionalized spouse, the spouse at home is allowed to keep, at least, the first $2,739 (and sometimes more) per month of both spouses' combined monthly incomes - for living expenses. If the at-home spouse's gross monthly income is less the $2,739, he or she will receive an allocation of the institutionalized spouse's income - in order to bring the at-home spouse's income up to (or as close as may be possible to) the $2,739 MMMNA limit.
So... if you are an at-home spouse, don't "over-spend" or "go broke" on nursing home expenses. Spend instead, just a little time with me, or any other elder law/Medi-Cal planning attorney, to learn about your options. Much of what you think must be sacrificed to the cost of nursing home care can actually be saved!
I have always referred to this anticipated, historical anomaly as "The Motive Year". With so many different seasons and versions of CSI behind us, I can't but jokingly think that some are already involved in a darker form of "tax planning".
However, if Congress does "nothing", 2010 will be the only taxless year. The federal estate tax will, under the existing law, spring back to life in 2011 (affixed with the original $1 million exclusion amount).
Representative Earl Pomeroy (D-N.D.), I believe, was one of the first to embrace this approaching oddity. Arguing more for the sake of saving the many farm-steads in his home state of North Dakota, he first introduced a bill in 2003 suggesting that the federal estate tax exclusion (which is now set at $3.5 million per person, with a 45% rate applying to any excess) be fixed at an even $3 million. In 2005 he repeated the process, then introducing a bill recommending that Congress adopt and fix a $3.5 million exclusion. Both of his proposals were rejected.
But now as the year draws to a close, the issue is drawing more attention.
Representative Jim McDermott (D-Wash.) has authored and introduced the "Sensible Estate Tax Act", as he has labeled it, which suggests the estate tax exclusion be lowered to $2 million (with any excess being taxed starting at 45% rates).
Representative Shelley Berkley (D-Nev.) has introduced a contrary bill which would set the exclusion level starting at $3.5 million, increasing it eventually to $5 million (by 2019) and starting with a 45% rate which decreases to a final 35% rate over the same time period.
Active lobbying by various groups is coming down on all sides of these proffered exclusion numbers. Those who argue in favor of lower exclusion numbers remind us that the federal government has invested huge amounts of money in the TARP and TALF programs, continues supporting our presence in Iraq and Afghanistan, continues its commitments and expenditures in Social Security, Medicare, and Medicaid, and is now embracing the health care reform bill with its estimated $1 trillion budget. Their summary? It's simple: a lower exclusion amount is necessary in order to generate badly needed revenue.
Opposing arguments include, notably, the comparatively small amount which the federal estate (and gift) tax contributes to the overall federal income picture. According to the statistics reported at the Tax Policy Center site (if this page has expired, from the main site search "historical quarterly receipts by source") of the Urban Institute and Brookings Institution - and employing some simple math - the federal estate and gift taxes constituted 1.34% of total gross tax collections in 2002 (this being the first year the $1 million exclusion applied). In 2007, with a $2 million exclusion in place, the estate tax generated .996% of total gross tax collections). There are, of course, no revenue numbers for the current year, but I expect another minuscule decrease in that benchmark 1.34% number.
I believe that Congress needs to recognize that "a million dollars" is simply NOT "a million dollars" anymore. If it chooses to install (or by default allow) the smaller $2 million (or $1 million) exclusion back into the estate tax scheme, many of the small and mid-size businesses and farms which form the backbone of this nation's economy, and which might otherwise contribute their part to our economic recovery, will instead over time and under pressure of confiscatory estate taxes, be carved-up and sold off in pieces, or closed-down, or simply abandoned . . . each time adding a complimentary donation to the unemployment rate.
And this choice will have added what? ... a fraction of a percent to the federal revenue base?
In the face of a persistent recession, decreasing the federal estate tax exclusion makes little sense.