Transfers to a Medicaid Irrevocable Trust

A Medicaid irrevocable trust, also known as an asset protection trust, may allow you to qualify for Medicaid benefits while preserving assets for family members or other beneficiaries. It is a legally enforceable arrangement that allows you to transfer property to someone else (the trustee) who holds the property for family members, typically children.

You and your spouse are not beneficiaries of this trust. Typically, one or more of your children would be the trustee. The trust is “irrevocable” meaning that you cannot amend or revoke it.

At the time of asset transfers to the trust, the “gift” is subject to the transfer of asset rules -- in most cases this is a five-year lookback period.

Under federal law, a state may not look back more than 60 months from the Medicaid application date in an attempt to find disqualifying asset transfers. In month 61, a Medicaid applicant is financially eligible for Medicaid because the gift made 61 months ago does not have to be disclosed to the State.

There are many benefits to establishing a Medicaid irrevocable trust:
  • Flexibility: You would retain some control over the trust, including the ability to add or remove beneficiaries, excluding yourself, or to change the trustee.

  • Life Use or Use and Occupancy Agreement: If you transferred your residence into the trust, you would either retain a life use in the house, or have a Use and Occupancy Agreement, permitting you to live there undisturbed and obligating you to pay the carrying costs of property. You would still be eligible to deduct the real estate taxes for income tax purposes.

  • Sale of Residence: If you transfer your residence or another property you own to the trust, you have the flexibility to sell the property during your lifetime. Thus, if your home is sold during your lifetime and you retained a life use, a portion of the sales proceeds based on the value of your life use would be payable to you, but most of the sales proceeds would be payable to the trust.

    Any gain would be reported on your individual income tax return. As such, you would qualify for the personal residence capital gains tax exclusion ($250,000 in the case of a single individual; $500,000 in the case of a couple). This is a significant tax benefit and ensures flexibility in the event the home is sold. Also, as discussed below, if the home is unsold at your death, it qualifies for the stepped up tax basis which will minimize any capital gains taxes that are later realized upon its sale.

  • Tax Benefits: The trust has substantial tax benefits. First the trust is a“Grantor Trust” for income tax purposes, which means that it is not recognized as a separate taxable entity. Consequently, the trustee is not required to file a separate income tax return during your lifetime. The income earned on trust assets is reported by you on your own income tax return and under your own Social Security Number.

The transfer of your assets to the trust for the benefit of children or other family members is not a completed gift for gift tax purposes (although it is a completed gift for Medicaid purposes). A gift tax return is required to be filed for the calendar year when assets are transferred to the trust.

Finally, the trust assets (except annuities) are eligible for a stepped-up tax cost basis to the fair market value on the donor’s date of death.

The cost basis is the value the IRS uses to determine gain or loss on the sale of capital assets (e.g., real estate and securities). A taxpayer’s cost basis is the sum that the donor paid for the asset plus, in the case of real property, any improvements to the property.

There is a tremendous income tax benefit to the trust beneficiaries in using the fair market value on the date of death as their cost basis, as opposed to the “carry-over” basis rule that typically applies to gifted assets (in which the donor’s cost basis transfers to the donees).

But what if something happens to me or my spouse during the 5 year lookback period and one of us needs to apply for Medicaid benefits?

Un-funding the Trust

If you transfer your house to the trust and you or your spouse enters the nursing home within five years, the trustee could gift the house back to the healthy spouse and, because the house is exempt, there is no harm in receiving the house back because it is an exempt asset. The healthy spouse could then spend down if need be.

Additionally, there are spend-thrift provision in the trust which provide creditor protection.

If you have transferred additional assets to the trust it is important to remember that should either spouse need long term care services prior to the end of the five-year look-back period all of the assets transferred to the trust will not be protected. It may then be necessary to use some of the gifted funds for the cost of care.

The trust is worded in such a way that will enable some trust property to be distributed to one of the beneficiaries and then distributed to you. The trustee should not pay any amounts from the trust directly to you or your spouse. In addition your trustee should keep good records of any expenses paid from the trust assets.