Life Estate Deed vs. Medicaid Asset Protection Trust

Life Estate Deed vs. Medicaid Asset Protection Trust

When making planning decisions for the future, there are several options to choose from. Two possibilities to protect your property are drafting a life estate deed or a Medicaid asset protection trust.

A life estate deed may work on certain occasions, like helping avoid probate or getting a stepped-up basis for the remainder men or remainder persons, usually the children, that receive the home once the holder of the life estate interest has passed away.

However, there are three significant disadvantages to using a life estate deed. The first major disadvantage is that Medicaid is still entitled to put a lien on the life estate interest of the life estate holder. For example, mom and dad deed the property to their three children, but they reserve their life estate in the property. However, if mom or dad becomes incapacitated and ends up in a nursing home, they may need to receive Medicaid benefits to supplement their care in a skilled nursing facility. Medicaid can still look to place a lien on the life estate portion of the ownership of the home.

The second disadvantage of a life estate deed relates to potential tax issues. For example, if dad passed away, mom may no longer want to live in the big house and pay the real estate taxes, homeowners insurance, and things of that nature. Therefore, she needs to sell the house and downsize or move in with one of her children. Since there is a life estate deed, not only does mom have to sign off on the sale, but so do the children since they have an interest in the property.

However, the children do not live in the house, which is not their principal residence. Therefore, they cannot benefit from Section 121 of the Internal Revenue Code. They will not get the capital gains tax exemption, a $250,000 coupon exemption on capital gains tax. Instead, they will have to pay capital gains tax on the home’s sale. To determine this, they will subtract their parent’s original basis of what they purchased the property for from the current sale price and then multiply by the capital gains tax rate. The current capital gains tax rate is about 20 percent; however, there could be changes in the law due to the current administration that raises it to 39 percent.

The third disadvantage relates to concerns for the mental capacity of the life estate holders. For example, if dad passed away and mom’s health declines, the children may want to downsize where mom is living. The property could be sold, and the proceeds supplement mom’s care. The children can sign the deed, although they will pay capital gains tax, but mom may have diminished capacity. With diminished capacity, she may not be able to sign that deed legally. As a result, the family may have to use a power of attorney if that power of attorney is legally sufficient to cover that power. If the family does not have a power of attorney or if the power of attorney is not enough, then the family will have to petition the probate court for a conservatorship. Getting a conservatorship costs time and money.

These three disadvantages of a life estate deed can cause many pitfalls in the future. Not only does it create concern for Medicaid liens but also tax issues, and the unknown of the mental capacity of all the individuals involved could cause problems.

A Medicaid Asset Protection Trust can actually remove all of these pitfalls. All that is needed is for it to be drafted property with the proper protections.

We specialize in educating and helping you protect what you have for the people you love the most. Contact us to learn more about how we can help.


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