Many people are concerned about protecting their assets from the cost of nursing home care.  This is not as easy as those radio ads would lead listeners to believe since preserving assets against long-term care costs often means transferring assets so that they are no longer accessible.  Transferring liquid assets such as bank accounts, mutual funds, or stocks and bonds is often not an option since those assets are being used to pay for living expenses, travel, health care, etc.  Transferring retirement assets such as IRAs or 401K accounts is not a good option because of the income tax consequences.

This leaves real estate.  Transferring real property to children while retaining a “life estate” can be a good asset protection planning strategy for parents trying to preserve the value of assets for children.  The parents usually continue to reside in the property and pay the expenses.  There are also some tax advantages to retaining a life estate in the transferred property. However, there are also risks associated with this strategy.

Here are five things to know about life estates.

1. What is a life estate?   A life estate is the right to use and occupy real estate for one’s lifetime. In the context of long-term care planning, a life estate typically refers to a scenario  in which parents deed their real estate to their children,  while retaining the right to live in the property for their lifetimes.  A deed with a life estate reads something like this:

“We, Mom and Dad, for $1.00, grant to our children, Alice and Bert, our home at 123 Elm Street, but we retain for ourselves the right to use and occupy the property for our lifetimes.”

The result of such a deed is that Alice and Bert are the owners of the property, but Mom and Dad have the right to continue to live in the property and pay the expenses for the rest of their lives.

2. Why do people use a deed with a life estate?  The primary reason for using this planning strategy is to protect the property from having to be used to pay the cost of long-term care.    Medicaid benefits, called MassHealth in Massachusetts, are the public benefits available to pay the cost of nursing home care for individuals with limited income and assets.  The rules that govern eligibility for Medicaid benefits permit an individual to own a home and receive Medicaid benefits to pay for nursing home care.  However, the Commonwealth will place a lien against the individual’s home so that the state can recover Medicaid benefits paid for the property owner’s care when the home is sold or when the Medicaid recipient passes away.   If the Medicaid recipient owns only a life estate in the home, then the lien is extinguished at his death.  Of course, the transfer of the home must have occurred more than five years prior to the individual applying for Medicaid benefits.

3. Sounds good – what’s the catch?  Although transferring property to children and retaining a life estate can be good asset protection planning in the right situation, there are consequences.  One of most serious is the potential risk to the property from the children’s creditors.  When a person transfers property to children, the children become the owners of the property.  If the owners of property incur liabilities, the property may be subject to those liabilities.  The types of creditor problems children may have include divorce, bankruptcy, loan defaults, tax liens, credit card debt, a lawsuit, etc.  Although the retained life estate means that a child’s creditors could not force the parents to vacate the property, those creditors could place liens against the property.

4. What if the parents want to move?  If Mom and Dad from my above example want to sell the house and move, then their children must agree to the sale since they own the property.  Even when parents believe that their children would be willing to sell the property, there could be circumstances that would prevent this from happening, such as a child’s death or incapacity.  If the property is sold, not all of the proceeds will belong to the parents.  Some of the sale proceeds will belong to the children.  The division of the proceeds between the owners (the children) and life estate holders (the parents) depends upon the ages of the life estate holders at the time of the sale.  The older the life estate holder, the smaller the ownership interest.

 5. And let’s not forget about taxes.   Some of the tax issues that need to be considered in connection with transferring property with a retained life estate include:

• capital gain taxes
• stepped-up basis
• exclusion of gain on the sale of a primary residence
• gift tax
• real estate tax exemptions offered by some towns; and,
• estate tax.

While a discussion of the tax aspects is beyond the scope of this article, it must not be beyond the scope of analysis when a person is considering whether or not to deed property to children with a retained life estate.

The above highlights some, but not all, of the issues that need to be considered before transferring real property for asset protection purposes.  While a deed with a retained life estate can be an excellent way to preserve the value of the home from liability for long-term care costs, it is vital to thoroughly examine the consequences before making the transfer.  An experienced elder law attorney can help you analyze advantages and disadvantages of using a deed with a retained life estate based on your particular situation.

October 2014

Attorney Suzanne R. Sayward is certified as an Elder Law Attorney by the National Elder Law Foundation, a private organization whose standards for certification are not regulated by the Commonwealth of Massachusetts.  She is a partner with the Dedham firm of Samuel, Sayward & Baler LLC.  This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney. For more information visit www.ssbllc.com or call 781/461-1020.