Q. My mother has been in a nursing home on a Medi-Cal subsidy for the last 18 months, and I know Medi-Cal will have a substantial “payback” claim when she passes. She owns a home which she bought 40 years ago for $40,000, which is now worth about $700,000. I worry about the growing Medi-Cal claim and also about capital gains taxes. My CPA says if Mom retains the home until she passes, the capital gain will be eliminated. But, wouldn’t that strategy expose the home to a Medi-Cal payback claim?
A. Yes, indeed. The problem is that the Medi-Cal rules and the tax rules work differently. On the tax side, in order to eliminate the capital gain associated with the dramatic appreciation in value of the home, mom would need to retain the home as part of her estate until she dies. Under current tax law, the home would then get a “step up” in cost basis equal to its value on the date of her death. This date of death adjustment would essentially wipe out all of the accumulated capital gain that would have to be recognized and tax paid if you later sold the home, and so your CPA is correct in this regard.
However, on the Medi-Cal side, if mom retains the home until she dies, it would then be exposed to a substantial Medi-Cal estate recovery claim equal to the value of all nursing home benefits paid out during life.
Hence, the dilemma: in order to avoid a Medi-Cal recovery claim, the home would have to be deeded out by mom during her lifetime so that it is not part of her estate at death. However, for tax purposes the optimal plan would be to retain it so that it remains part of her estate at death, and thereby passes to her children unburdened with capital gain.
Good news! There is a way out of this dilemma: The optimal plan is to structure a conveyance of the home during mom’s lifetime which, for Medi-Cal purposes, is complete, but which for IRS purposes is incomplete. I call this plan “Eating Your Cake and Having It, Too”.
Since the Medi-Cal rules and the IRS rules are different, this plan takes advantage of the differences in the two bodies of law. The transaction would be structured so that the home would be conveyed out during mom’s lifetime to her children, but with mom retaining the legal right to return to live in the home if able to do so. For IRS purposes, the conveyance would then be considered incomplete, as it was made with “strings attached” (i.e. the right to return home). It would become complete only upon her later death, thereby embracing all of the favorable capital gains benefit associated with a death transfer. However, for Medi-Cal purposes, the transfer would be considered complete, so that the home would not be a part of mom’s estate upon her later demise and thereby would not be exposed to a Medi-Cal estate recovery claim.
If properly structured, this strategy would (a) protect the home from a Medi-Cal estate recovery claim, (b) result in a transfer of the home to mom’s children unburdened by the accumulated capital gain, and (c) avoid the later need for a probate or a formal trust administration.
And remember: just as it is perfectly lawful for the wealthy to plan their affairs to minimize tax liability, so, too, is it lawful for middle-income folks to plan their affairs to avoid a Medi-Cal estate recovery claim. While both strategies can be said to impact the public treasury, the impact of the former is greater by far.
Note: The above plan assumes that the home will not be sold during mom’s lifetime. If a sale were contemplated, another strategy would be used involving the creation of a specially designed irrevocable trust to both preserve the $250K homeowner’s exemption upon sale and to avoid the influx of sale proceeds directly to mom so as to preserve her Medi-Cal subsidy.