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The typical planning involves the drafting of an irrevocable trust which is funded with your  primary residence. The assets transferred to the trust will be protected from the cost of a nursing home five years from the date of the transfer to the trust.

Who benefits from using an irrevocable Medicaid trust?

Irrevocable Medicaid trusts are generally recommended for individuals over the age of 60, especially if your goal is to protect your assets from the costs associated with long-term care, such as nursing home costs.

What does it mean when someone is the Donor of an irrevocable trust?

The individual who creates the trust is referred to as the Donor. The Donor is able to maintain a certain amount of control over the trust, even if he or she does not serve as Trustee. The Donor has the power to remove the Trustee and can retain a right to receive trust income.

Who can be the Trustee?

Current law allows the Donor to serve as the Trustee, but we recommend that the Trustee of the irrevocable trust be someone the Donor trusts, such as a child or other family member. If the Donor decides to serve as the Trustee, the trust will be drafted so the Donor does not have too much control over the trust property. This will ensure the protection of the Trust assets.

How do Medicaid trusts avoid the costs associated with the probate process?

Anyone who owns assets in their name individually, without a designated beneficiary, at the time of their death will subject those assets to the costs of the probate process. By creating an irrevocable trust and transferring ownership (or “title”) of assets to the Trustee, you can reduce or eliminate the number of assets that must go through the probate process. This will reduce costs such as filing fees, attorney fees, and appraisal expenses.

How long does it take before the trust can protect assets from the costs of long-term care?

Once assets have been properly transferred into the irrevocable Medicaid trust, the assets will be protected from the costs of long-term care five years after the date of the transfer. This is referred to as the five year “look-back” period for Medicaid eligibility. When you apply for Medicaid benefits, the state is entitled to review all of the financial transactions you’ve made during the previous five years to determine if a “disqualifying transfer” has been made.

What kind of assets should I transfer into my irrevocable Medicaid trust?

IRAs or any other qualified plan or retirement asset like a 401(k) or 403(b) cannot be transferred into these trusts during your lifetime without adverse income tax consequences. Instead you should live off of these assets, since they will not be protected from the costs of long-term care.

Most people transfer their primary residence into the trust, and sometimes a rental or vacation property. Many individuals also transfer their investment portfolios, or at least a portion of them. All of these assets can be transferred to the irrevocable Medicaid trust without any adverse income tax consequences.

Can these irrevocable trusts be changed in any way after they are created?

The trust is irrevocable, however some elements may be changed through a limited power of appointment held by the Donor. In other words, the Donor has the power to change the beneficiaries of the trust, but generally is limited to a class consisting of the Donor’s issue (children, grandchildren, etc.) and charitable organizations. Using this power, the Donor may add or take away beneficiaries, or reallocate the distribution of trust property by changing percentages given to each beneficiary. By retaining these powers, the Donor also retains a certain degree of control over the trust principal.

Can I add assets to the irrevocable Medicaid trust years after it’s been created?

Yes. You can transfer assets into the trust any time after the trust has been created. However, keep in mind that the addition of assets to the trust will effectively begin a new five year look-back period with respect to the new assets transferred. This new look-back period will not effect assets that were previously transferred to the trust.

Do I have to sell the assets in my investment portfolio to transfer them into the irrevocable trust?

No. You can re-title the existing assets in your investment portfolio to the name of the trust, which just means changing the investment assets from your name to the trust’s name, so there will not be any adverse tax consequences when you re-title your investment account.

Are there any investment limitations placed on the Trustee of the trust?

No. The Trustee has the power to invest and re-invest in all of the same investment options that would be available to an individual investor. The Trustee does have a fiduciary duty to the Donor to make investment decisions prudently. However, you should remember that there are no IRAs or qualified retirement plans held in the trust.

How do I transfer real estate into the irrevocable Medicaid trust? Are there any tax consequences?

Transferring real estate into the trust is generally done by preparing a new deed. This deed will transfer the property from the Donor’s name to the Trustee of the irrevocable trust.

There are no adverse income or gift tax consequences when you transfer real estate to an irrevocable Medicaid trust.

If I transfer my home into the trust, am I able to sell it at any time afterward? How?

Yes, you can sell your home after it has been transferred into an irrevocable Medicaid trust. The Donor of the trust can direct the Trustee to place the home on the market to be sold. The Trustee would sign the purchase and sale agreement to complete the transaction. The proceeds from the sale would be paid to the Trustee, who would deposit the funds to the trust bank account. The Donor should not receive the proceeds. These proceeds will now be protected from the costs associated with long-term care, just as the home itself was.

The sale of a home does not affect the five year look-back period for Medicaid eligibility purposes. The look-back period begins on the day the home was transferred into the trust, not the day the home was sold from the trust. Furthermore, this would not be considered a disqualifying transfer since the home is being sold for market value.

Can the Trustee of the trust purchase new property?

Just as the Trustee can sell real estate from the trust, it has the power to purchase real estate on behalf of the trust. This means the Trustee can purchase a new home using the proceeds from a previous sale. None of these transactions will re-start the five year look-back period for Medicaid eligibility purposes.

Do I need permission to buy or sell real estate after it has been transferred into the trust?

No. As Donor of the trust, you are able to instruct the Trustee to buy and sell property as you wish. In the unlikely event that the Trustee does not comply, you may exercise your power to remove and replace the Trustee at any time and thus can replace the current Trustee with one that will comply with your wishes.

Will I still receive my capital gains tax exclusion upon the sale of my primary residence after it has been placed into the irrevocable Medicaid trust?

Yes. The capital gains tax exclusion gives married individuals the opportunity to shelter the first $500,000 of capital gains on the sale of their primary residence while allowing single individuals to shelter the first $250,000 of capital gains on the sale of a primary residence. In order to utilize this protection, you must have owned and used the property as your primary residence for two of the last five years. Since an irrevocable Medicaid trust is drafted as a “grantor trust” for income tax purposes, the Donors will not lose their ability to take advantage of this capital gains exclusion if the property is sold from the trust.

The term “grantor trust” means that the Donors (the creators of the trust) are considered the owners of the trust for income tax purposes, and therefore retain their ability to utilize the capital gains tax exclusion on their primary residence.

What are the implications of transferring rental property into the trust?

There are no adverse tax consequences of transferring rental property into the irrevocable Medicaid trust. Much like a primary residence, the property can be sold and the proceeds could be used to purchase new property without adverse tax implications. You would still be able to collect rent, pay any bills associated with the property, make decisions regarding rental increases, remove tenants, etc.

After rental property is transferred to an irrevocable Medicaid trust, what happens to the rental income?

These trusts are designed as income-only trusts, which means that the trustee is obligated to pay out the income earned by the trust to the Donor. Specifically, the tenants would write their rent checks to the trust, and the Trustee would deposit the funds in a bank account set up for the trust using the trust’s own tax identification number. This number would be acquired from the IRS. A request can be filed easily online.

The rental income represents the trust’s income, which the Donor receives. The Trustee must write a check from the trust’s account in the amount of all rental income to the Donor, who can deposit it into his or her personal account and use the funds at his or her discretion.

Does an irrevocable Medicaid trust have to file a separate income tax return? If so, will this lead to an increase in income tax liability?

The trust is not required to file an income tax return if the only trust asset is the Donor’s primary residence. If you itemize your tax deductions, the real estate taxes will be reported on Schedule A of your personal income tax return.

If the trust generates income, then it must file a fiduciary income tax return. The trust must obtain a tax identification number for this purpose, if this has not already been done.

Because the trust is a grantor trust, the trust will not pay any additional income taxes. The Donor is treated as the owner of the trust for income tax purposes, and any trust-generated income flows through the trust and is reported on the Donor’s individual income tax return (the Form 1040), just as it would be if the trust did not exist. Because of this, irrevocable Medicaid trusts are said to be “income tax neutral,” causing no change in the Donor’s income tax liability.

Will transferring assets into the trust subject me to gift tax liability?

No. Gifts made to irrevocable trusts are known as “incomplete gifts” for gift tax purposes because the Donor retains the right to change the trust beneficiaries. Furthermore, no gift tax returns must be filed for transfers to the trust, except if the Donor wishes to disclose the transfer into the trust to begin the running of a statute of limitations.

Upon the death of the Donor, do the trust assets receive a step-up in basis for capital gains tax purposes?

Yes. A step-up in basis means that the cost basis of an asset in the hands of the beneficiaries following the death of the Donor would be equal to the fair market value of the asset received as of the date of the Donor’s death. A stepped-up basis is advantageous because generally if the beneficiaries were to sell the asset soon after the Donor’s death, there would be little or no capital gains tax liability to the beneficiaries. Compare this to a transferred basis (such as when property is given to a child), which would value the asset at the price the Donor paid for it, almost guaranteeing a higher capital gains tax liability upon a subsequent sale.

For example, if the Donor of the trust purchased an asset long ago for $40,000 and put $10,000 worth of improvements over the years, the Donor’s cost basis of the asset would be $50,000. Now assume the Donor transferred the asset into an irrevocable Medicaid trust and upon the Donor’s death the asset is worth $200,000. Upon the death of the donor, the beneficiary would receive a cost basis in this property equal to the fair market value of $200,000. If the beneficiary then sells the property for $200,000, there would be no capital gains taxes to pay. There is a much different result when a property is gifted to a child. If the child sold the property using a $50,000 carry-over cost basis, $150,000 would be subject to capital gains tax.

Should I use one or two irrevocable trusts when protecting assets from the costs of long-term care?

If you are single, then only one irrevocable trust is necessary. If you are married and the value of your assets exceed $1,000,000, or may exceed $1,000,000 over the course of your lifetime, you may want to consider using two irrevocable trusts. Using two trusts will enable you to protect your assets from the costs of long term care and to utilize both of your federal and state estate tax exemption equivalent amounts, thereby serving to reduce your estate tax liability.

Can the Donor borrow against real estate that has been transferred to the irrevocable trust?

The Donor generally cannot borrow against real estate that has been transferred into the trust. If you have an existing mortgage on property that is transferred into the trust, you will be prohibited from refinancing the debt once the transfer is complete. The transfer of the property to the trust will NOT trigger the due-on-sale clause in the mortgage. If obtaining financing is important to you, you should establish an equity line prior to transferring the property to the trust. You may not be able to renew an equity line once it expires.

Is the Donor able to receive principal from the trust?

In order to protect the trust assets from the costs of long-term care, the Trustee must be prohibited from distributing principal directly to the Donor. This usually isn’t a problem for most people because the trust income (and other income such as social security and retirement accounts) is often sufficient to live on.

If an individual were to completely run out of assets to live on—both income from the trust and assets outside of the trust—there is always the provision in the trust that allows the Trustee to distribute principal to the beneficiaries (usually the Donor’s children). Once the gift has been made to the child, the child can then give the money back to his parent (the Donor). The parent can spend the money as he or she wishes. The money that the Donor receives would be at risk from the costs of long-term care, but the other assets in the trust would continue to be protected.