Will a Life Estate Deed Protect My Home From Medicaid?

A popular Medicaid planning strategy in the past has been transferring a home to children, while reserving a “life estate” interest on the deed. The grantor-owner would be the “life estate holder” and the children would be the “remaindermen,” becoming the outright owners upon the death of the grantor. The value of the retained life estate would reduce the amount of an uncompensated transfer of assets assessed by Medicaid^[1] versus an outright transfer to children, and the life estate would allow the grantor the retained right to reside in his or her residence during his or her lifetime. Further, the home would avoid probate and, therefore, by unofficial current New York State practice, the life estate would likely not be subject to Medicaid estate recovery,^[2] while allowing the owner to preserve his or her tax benefits, including residential tax exemptions such as STAR or veteran’s exemption, the personal residence exclusion from capital gains and a stepped-up basis value of the home upon death of the grantor.^[3]

In many cases, this strategy worked well, and it was very popular about 15 years ago. However, many situations have revealed serious issues with this plan, which deem life estate deeds generally an ill-advised strategy for anyone concerned about maximum protection of their home.

The Potential Pitfalls of a Life Estate Deed

If the Property Is Sold During the Grantor’s Lifetime

If the grantor requires nursing home care and cannot move back home, it is not uncommon that the family members would choose to sell the home to eliminate the ongoing financial burden of carrying costs and maintenance of the property that they would have to bear.

The Grantor Is Entitled to Part of the Proceeds

If the property is sold during the grantor’s lifetime, there is a percentage of the sale proceeds that is legally required to be paid to the grantor, as the life estate holder, with the balance to the children, as remaindermen. The value of the life estate and remainder interest is an actuarial calculation based on the value of the property and the age of the life estate holder as per Internal Revenue Service tables.[4] The portion that is paid to the grantor may result in him or her being over-resourced and no longer eligible for Medicaid without further planning. He or she may still be able to salvage and protect some of the proceeds with other crisis planning strategies, but in most cases a significant portion will likely go toward nursing home costs.

The Children Are Not Entitled to the Capital Gains Exclusion

If the property is the grantor’s primary residence and is sold during the grantor’s lifetime, then the grantor is entitled to up to a $250,000 capital gains exclusion that is not subject to tax (and up to $500,000 if grantors were a married couple).^[5] This significantly reduces, and often completely eliminates, any tax liability when selling a primary residence. The remaindermen, the children, would not be entitled to this tax exclusion, unless they also lived in the home, so their entire gain would be subject to capital gains tax. This could result in tens of thousands of dollars, or even more, of a tax liability to the children, which could otherwise have been preserved had the grantor retained full ownership (either outright, or in a qualifying trust).

For example: Betty, together with her husband Paul, bought their home for $200,000. They transferred their home to their children and retained a life estate. Paul dies and the home is then sold with net proceeds of $1 million. Based on Betty’s age and the market value of the property, using the applicable actuary tables for calculating her share of the sale proceeds, Betty receives approximately $350,000* (*estimate) of the proceeds. Although she is entitled to a $500,000 capital gains exclusion (based on it being her and Paul’s primary residence for at least two out of the most recent five years), the exclusion is only useful for her share of the proceeds. This results in her share not being subject to any capital gains tax, but the balance of the unused exclusion amount is lost. On the other hand, her children, as remaindermen, receive $650,000 of the proceeds (split between them), but as this was not their primary residence, they do not get any capital gains exclusion and are each subject to pay many thousands of dollars in capital gains tax. Further, because Betty is in a nursineg home, she is now ineligible for Medicaid coverage as payment of the proceeds resulted in her being over-resourced.

If a Remainderman Predeceases the Grantor

If a child is a remainderman on a life estate deed and passes away, this can be a tremendous problem for the grantor.

The Grantor Now Owns the Property With an In-Law Child or Minor Children

The new remainderman will now be whoever the deceased child named in his or her last will and testament, and if there was no will, whoever inherits from his estate by law.^[6] This could result in the grantor now owning his or her home partially with a daughter-in-law or son-in-law or with minor children subject to court oversight. This can be a serious problem if the grantor wants to sell or mortgage the home or needs the remainder interest returned to avoid a penalty during a Medicaid lookback period. First, the deceased remainderman owner obviously can no longer “return” the gift, and the new inherited “remaindermen” may not be willing to transfer his or her interest to the grantor, may not be interested in returning money from a sale to the grantor or, in the case of minor children, no one would have the authority to do so, as the children’s inheritance would need to be safeguarded and cannot be given away based on the grantor’s original intent.

The Grantor Might Be a Beneficiary of a Remainderman’s Estate

If a child that is a remainderman dies during the grantor’s lifetime, without a spouse or children, then the grantor is the distributee, the beneficiary by law, of the deceased child’s estate.^[7] If the grantor is on Medicaid, this could be a problem. If the house is sold during the grantor’s lifetime, a probate or administration proceeding would be needed for the deceased child’s estate before a sale could be completed, and the grantor may be entitled to the deceased child’s estate’s share of the proceeds, which likely would over-resource the grantor for Medicaid purposes. Further, if the house was only sold after the grantor’s lifetime, a probate or administration proceeding for the grantor’s estate would be required as well for the deceased’s child’s remainderman interest. When the grantor’s estate is probated, the estate would then be exposed to Medicaid estate recovery. A conundrum indeed!

If the remaindermen held interest as joint tenants with rights of survivorship, that would likely mitigate the risk of the grantor being left with a remainder interest if a remainderman predeceased the grantor, but if the grantor’s intention is to distribute his or her estate equally between children, per stirpes, joint tenancy would not work, as the deceased child’s children would not inherit.

If a Remainderman Becomes Estranged

A grantor-life estate holder needs the cooperation of the remaindermen if he or she wishes to sell the property, add an additional remainderman, obtain a mortgage or do any trust planning in connection with the property held by the life estate deed.^[8] If a remainderman child becomes estranged with the life estate holder, tremendous challenges can arise.

First, the grantor cannot remove the estranged child’s remainder interest without the consent and cooperation of such child because a new deed requires each remainderman to sign the deed and related transfer tax documents transferring his or her interest back to grantor or otherwise forfeiting his or her remainder interest. Second, the uncooperative remainderman can prevent the property from being sold or mortgaged, which sale or loan proceeds may be needed to pay for a grantor’s living expenses or long-term care.

If a Remainderman Becomes Incapacitated

If a remainderman becomes incapacitated, without a valid power of attorney permitting such action, the grantor will be unable to sell the property, change the deed in any way or utilize Medicaid planning strategies if necessary. The grantor would be required to proceed with a guardianship proceeding and request the court’s permission to take action with regard to the property, which the court will not necessarily grant if not in the interest of the incapacitated remainderman.

Further, the incapacitated remainderman may be on Medicaid or receive SSI benefits. This would be problematic if the grantor needed the return of gift (it would be an uncompensated transfer by the remainderman), or if the remainderman received a portion of the sale proceeds (which could jeopardize his or her government benefits). A disabled remainderman would be limited by the applicable rules of the government program from which he or she is receiving benefits, which may jeopardize a portion of the market value or jeopardize his or her own benefits.

If a Remainderman Is Sued

As we discussed, the grantor’s objective with a life estate deed would be to protect the home during one’s lifetime and ensure the smooth transfer to one’s children after his or her lifetime. But what happens if a remainderman is sued during the grantor’s lifetime? The remainderman’s problems can become the grantor’s problems. Creditor judgments and tax liens against a remainderman can attach to the property interest.^[9] The creditor can lien the property, and once the life estate holder (the grantor) dies, the creditor could foreclose on the property. A lien and resulting foreclosure will affect not only the debtor remainderman, but the interest of all the remaindermen.

Further, during the lifetime of the grantor, a creditor lien could prevent the life estate owner the ability to obtain a loan and get equity from the house. It is not uncommon for a life estate holder to apply for a mortgage to obtain funds to pay for home repairs, long-term care costs or other living expenses. That could be done if the remaindermen all consent, but if there is a creditor involved, a loan will not be possible until that is cleared up. A life estate can result in a remainderman’s problems becoming the life estate owner’s problems. This is one more reason why life estate deeds are ill-advised.

In summary, there are many unanticipated situations that can result in an unintended and disastrous effect with a life estate deed, and all possibilities should be carefully evaluated before going that route. Above are some of the reasons why trust planning is a much safer and more optimal method for long-term care asset protection planning.

Esther Zelmanovitz is the principal attorney of Esther Schwartz Zelmanovitz, in Great Neck, New York, focusing on the practice areas of estate planning, elder law, guardianships and probate and estate administration. A previous version of this article appeared in Elder Law and Special Needs Law Journal, the publication of the Elder Law and Special Needs Law Section of the New York State Bar Association. For more information, please visit NYSBA.ORG/COMMITTEES/ELDER-LAW-SPECIAL-NEEDS-SECTION.

[1] 18 N.Y.C.R.R. § 360-4.4(c)(2)(i) (f); 96 ADM-8 at p. 20, N.Y.S. Medicaid Reference Guide p.353.

[2] While the guidelines do provide for Expanded Medicaid Estate Recovery (recovery beyond the probate estate) in practice, it has not been and is currently not pursued in New York State.

[3] 26 U.S.C. §§ 121, 1014 and 2036.

[4] The Internal Revenue Service (IRS) provides an actuarial table, “Table S, Single Life Factors,” in accordance with the most recent mortality table, “Table 2000CM,” and interest rates under IRS Code 7520, “Section 7520 Interest Rates.”

[5] 26 U.S.C. § 121.

[6]  EPTL § 4-1.1.

[7]  EPTL § 4-1.1.

[8] N.Y.S. (RPP) Chapter 50, Article 8 § 243.

[9]  CPLR 5201(b).