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Guide to Long Term Care Planning

Medicaid Planning

How to Protect Your Family's Assets from Devastating Nursing Home Costs: Medicaid Secrets How to Protect Your Family's Assets from Devastating Nursing Home Costs: Medicaid Secrets (2014 Edition)
author: Gabriel Heiser, J.D., Attorney.

This book is a financial and legal guide to the ins and outs of the only government program that will pay for the long term nursing home care of your family member: MEDICAID.

$47.00 | 247 pages | More about the Book

Book:

Disclaimer: The following information is a description of some strategies people use to accelerate Medicaid's payment of their long-term care. This information does not constitute legal advice. You should always contact a lawyer or a qualified planner and not attempt these strategies yourself.

Introduction

Medicaid is discussed in some detail in the section called Medicaid Long Term Care. Generally, Medicaid comes into play for seniors when there is a need for nursing home care. Nursing homes are extremely expensive. Most older people do not have the income necessary to cover nursing home costs especially if there is a healthy spouse living at home. They generally rely on accumulated assets to cover the difference. The nursing home's expensive costs can chew away assets rather quickly. The only way to preserve any assets under Medicaid nursing home coverage is to transfer those assets to the intended heirs at some point prior to needing a nursing home or during the nursing home stay.

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Medicaid (Medi-Cal in California) will generally pay for certain health services, long term care services such as home care, and nursing home care for those with low incomes and limited resources. Medicaid has limitations on the amount of assets a person may own and the amount of income a person can receive each month before they are eligible. Eligibility and services vary from state to state.

Find Medicaid Planning Services in your area.

Transferred assets will cause a penalty. But transferring assets will also allow Medicaid to pay for its share of care at an earlier point. The goal of this planning is to get as much money into the hands of the healthy spouse or the children and reduce the amount of assets that have to go towards the private pay cost of a nursing home.

Medicaid planning (using a professional Medicaid planning advisor or qualified elder law attorney), allows you to correct inequities in the system. Medicaid planning has gotten a bad name because some individuals, who would normally have too many assets to ever qualify for Medicaid, deliberately use it, many years in advance, to give away everything to their family so as to qualify for Medicaid. It is wrong to abuse the system in this way and to use taxpayer dollars to insure an inheritance for the family. And if that person is not anticipating immediate care, this type of planning is just plain dumb.

Our own experience with Medicaid planning is that there is no intent to take advantage of the system. In almost all cases the family is confronting an immediate need for long-term care and there is usually not enough money to pay for it out of pocket. They are looking for advice on how to get Medicaid to cover that care. Most families using Medicaid planning have very little assets to begin with. Most are simply concerned with keeping the house in the family. Children have seen their parents struggle to preserve and have pride in an asset they can call their own and possibly pass on to children. To be thwarted in trying to preserve the family home because of Medicaid recovery just doesn't seem right somehow.

Families feel the same about the small amount of savings that parents have accumulated over the years. It seems unjust to families to wipe out these accounts when other government health services don't require a sacrifice of assets. And indeed, the concept of Medicaid recovery seems to be only unique to Medicaid services. Federal disaster relief, crop protection, Medicare services, aging services and programs for low income individuals do not require families to hand over their assets after the recipient dies.

Some Medicaid planners will attempt to discredit other forms of funding long-term care such as using insurance or a reverse mortgage. They do this in order to discourage the public from using these other strategies. The intent is to limit competition ensuring that paying clients will rely entirely on Medicaid planning as a solution. On the other hand, many long term care funding specialists will use the same strategy against Medicaid planners to eliminate competition from their services. These people make Medicaid planners appear as evil or dishonest. Medicaid planning is not much different from tax planning. In fact a Supreme Court decision condones honest methods of eliminating income taxes or estate taxes. Tax planning and Medicaid planning both put an additional burden on taxpayers, but one is considered ethical and the other not.

We believe that all strategies have their place in the scheme of things. Medicaid planning fits certain circumstances usually where families are in a crisis mode trying to preserve a few assets such as a house or a savings plan. There is no attempt to take advantage of the taxpayers. Using other strategies for paying the cost of care is much better for a younger generation wanting a plan that will allow for home care, assisted living and a choice in care services.

Below are a few of the strategies used to protect income and assets. Since Medicaid rules vary from state to state, you need to talk to a qualified planner or elder law attorney in your state to see the range of planning tools that can be used for your particular situation.

Dealing with Medicaid Penalties

Gifting assets for Medicaid purposes creates a penalty. The penalty is determined by dividing the amount of gifted asset by the state Medicaid rate. This is supposed to be the average monthly nursing home cost in the state. Suppose John gave away $200,000 and his state Medicaid penalty rate is $5,000 per month. John's penalty is 40 months. This means that when John would otherwise qualify for Medicaid and he applies for benefits, he must pay for his own care for an additional 40 months before Medicaid will take over. If the $200,000 that John gave away is not available to pay for this extra 40 months of care, John has a real problem.

The planning that is done in conjunction with these gifts must take into account how the penalty period will be covered. There are a number of strategies that address this issue. Some of the more common ones are discussed below.

The Look Back Rule

The Medicaid penalty is assessed up to five years after the date of gifting the asset. Using our example above, if John gives away his $200,000 on January 1 of 2011, and he applies for Medicaid prior to January 1, 2016, he will be assessed his penalty. If he applies after January 1, 2016 the penalty will not be assessed.

There is a hidden danger in applying for Medicaid within the five-year look back period. If the amount of money gifted is too large, the penalty can exceed five years and it's better either not to do the gifting if one is anticipating Medicaid within five years or to somehow figure out how to get past the five years if a large sum of money is gifted.

For example suppose John had given away $600,000. If the Medicaid penalty rate is $5,000 a month, his penalty is 120 months or 10 years. With this kind of penalty Medicaid would likely never have to pay any of John's care costs. Obviously with a gift this size John would design a strategy where he would definitely not apply for Medicaid within the five-year look back. Such strategies can be designed so as to maximize the amount of money ending up with the surviving spouse or other intended beneficiaries.

Half a Loaf Strategy for Medicaid

Anyone desiring help with Medicaid to pay for nursing home costs must have less than $2,000 in his or her name. If someone starts out with a substantial amount of money and ends up in a nursing home, that money must be spent down to less than $2,000 before Medicaid will help cover the cost of the nursing home. Sometimes a Medicaid recipient would like the family to have some of his or her money instead of spending it all. By the way, the money does not have to be spent on nursing home care. It can be spent on anything as long as it is not given away to someone else or used to buy something for less than its actual value from another person.

One strategy to get money into the hands of family members or someone else who might benefit from that money is to use the so-called half a loaf strategy. Here is how it works.

Suppose Jim has $102,000 in the bank and wants to give this money to his son. Jim could give $100,000 plus a few pennies to his son and then apply for Medicaid. Assuming he meets the medical requirement for Medicaid, Jim would be eligible except for the fact that he made a gift. Assume that the state Medicaid penalty rate in Jim's state is $5,000 a month. Jim has incurred a 20 month penalty and cannot receive help from Medicaid until he has paid the difference between the nursing home cost and his income for 20 months. Jim's income is $2,500 a month and the cost of the nursing home in his case is actually $5,500 a month. Jim has to come up with another $3,000 a month for 20 months or a total of $60,000. Knowing this, Jim could give the full $100,000 away and his son could use $60,000 of the money to cover the difference in cost and pocket the extra $40,000. After $60,000 is spent on his behalf, Jim has met the penalty and Medicaid takes over and his son can keep the remaining $40,000. In some states, the money given back on Jim's behalf by the son could be a reinstatement of the gift and could actually reduce the penalty on a month-to-month basis. In this way, the son could actually keep more of the money by reducing the penalty month to month.

Another way to cover the penalty is for Jim to give $60,000 to his son and retain $40,000. This produces exactly a 12 month penalty from Medicaid. Jim buys a 12 month income annuity with the $40,000 that pays 2% a year in interest and gives him $2,990 a month for 14 months. Jim must be careful that the income he creates is a little less than his actual cost. If his income exceeds his actual cost, the state will not consider that he is meeting his Medicaid penalty and the strategy has been in vain.

This gifting strategy allows him to give an additional $20,000 to his son over the previous strategy. In this case, the son pockets $60,000 of the $100,000 instead of pocketing $40,000 as in the previous strategy example above are.

This second strategy is called the half a loaf strategy. So why not use this second strategy all the time since it puts more money into the hands of a beneficiary? If the penalty generated by a gift is less than 12 months, it is difficult to find an insurance company that will create an annuity income for fewer months than that. Some companies might go with 10 months but very few will go with less than 6 months. Without being able to convert the asset to an income, Jim has defeated his purpose and has to go with the first strategy.

Medicaid Funeral Trust

Medicaid generally allows $1,500 to be set aside for purposes of burial that does not have to count toward the asset limit. Most states allow for more money to be set aside if it is held in a specially designed trust for Medicaid purposes. This is called a Medicaid funeral trust. Many of these trusts use guaranteed issue life insurance to create the cash at death. A funeral trust for the amount of a typical funeral should be set up from existing assets for the client and the client spouse prior to any other gifting strategies. It is not useful to put more money than is needed into the trust because any unused money will go back to the state. Some states allow up to $20,000 per trust.

Community Spouse Annuity for Medicaid

There is an asset test for Medicaid long term care purposes but essentially no income test. Even in those 22 states that do employ a strict income test for qualification, people can qualify with more income simply by putting their cash flow stream into a certain kind of approved trust for Medicaid purposes. These are typically called income qualifying trusts or more commonly Miller trusts. Since there is essentially no income test, a good way to divest assets for purposes of qualifying for Medicaid is to convert those assets to income.

Unfortunately, Medicaid is wise to this practice and for a Medicaid recipient to convert assets to income hoping to have Medicaid pick up the difference and after have the remainder of the income stream go to a member of the family does not work. There are certain rules and penalties for doing this that basically shut down this strategy.

There is one strategy for converting assets to income that is still allowed under certain conditions. Previously we learned that a married couple is required to split up their assets with the so-called community spouse keeping her state-allowed portion for her needs and the nursing home spouse having to spend down his share of the assets before one can qualify for Medicaid. He could certainly employ the half a loaf strategy with someone other than his wife, but she should be the recipient of the extra assets in order to maintain the lifestyle that was experienced before nursing home care threatened to destroy everything.

The strategy is called a community spouse Medicaid annuity. Here's how it works. Suppose Fred and Mary divided up their $100,000 in resources each taking $50,000 when Fred applied for Medicaid. (In about half the states this division of assets might work somewhat differently and Mary could keep the entire $100,000). Fred has to spend his $50,000 down to less than $2,000 and then Medicaid will take over his uncovered nursing home costs. Instead, Fred transfers his $50,000 to Mary.

As far as Medicaid is concerned, the $50,000 still belongs to Fred even though Mary now owns it. But Mary can buy an income annuity with this $50,000 that meets certain Medicaid rules and this income annuity has turned the asset into a non-countable income stream. Fred is now eligible for Medicaid and Mary has additional income that can help her deal with her needs in the community. If Fred dies before the end of the annuity payout, the balance of that payout, up to what Fred owes Medicaid for covering his care costs, must be paid to the state. Mary gets to keep what's left.

Some states are really not very cooperative about allowing this practice and seem to try every tactic possible to discourage these types of arrangements even though under federal law they are legal. Other states are more amenable. Every state that has been challenged up to a federal court level has so far lost its case in trying to prevent these kinds of arrangements.

Personal Service Contracts for Transferring Assets

A personal service contract is a paid services arrangement between a member of the family and the person needing care. Typically, children or grandchildren will care for aging loved ones in their home. They might provide help with activities of daily living such as getting out of bed, dressing, bathing, using the bathroom and so forth. Help might also be provided with cooking meals, cleaning, answering the phone, running errands, paying bills and so on. In some instances, constant supervision must be provided for loved ones who suffer from dementia or severe memory loss.

Family members often offer these services without reimbursement. There are many reasons why family members could be paid for their services under a personal service contract. Probably the most important is a situation where a family member has limited employment or quit employment altogether in order to take care of a loved parent or grandparent at home. Being paid for this care helps compensate for loss of income. Another reason might simply be that if there are assets to pay for the care, the family members providing care deserve to be paid for their time.

Personal service contracts can also be used to transfer assets prior to application for Medicaid. As we learned previously, transferring assets to a member of the family where no legitimate product or service of equal value is provided in return, results in a penalty from Medicaid when application is made.

Most states allow a potential Medicaid applicant to transfer money to children or grandchildren in exchange for legitimate care services provided at home or in the facility. One state in particular -- Florida -- allows a lump sum to be set aside to provide care for the remaining years of the Medicaid recipient's life. In other words, someone anticipating Medicaid in Florida, could transfer 7 years worth -- for a family member with that amount of life expectancy -- of money for personal care services from a member of the family and essentially remove that money from the estate.

For example, suppose Mary set aside $150,000 in a special account for her daughter Melissa to provide care for the rest of Mary's life. If this is done properly and following the correct rules in Florida, the $150,000 does not count as a gift and does not produce a penalty when Mary would apply for Medicaid.

Most states do not allow this kind of a lump sum set-aside. They only allow money to be gifted on a month-to-month basis. This is still a valid strategy if it is started years before applying for Medicaid. A substantial amount of money can still be transferred to the children without creating a penalty.

Personal care service contracts must be created in accordance with the rules set by each state. This usually means an acceptable care contract, care logs to provide evidence of providing the services and evidence that the person providing the care is billing the services at a reasonable cost. In most cases a reasonable cost would be somewhere around $20-$30 an hour.

Other Potential Strategies for Accelerating Medicaid Payment and Gifting Assets

We could provide pages and pages of additional strategies that are acceptable for accelerating Medicaid payment and gifting assets without triggering a penalty for Medicaid. Here is a list of just of a few of these strategies.

  • using a promissory note to transfer property
  • converting countable assets to exempt assets by purchasing automobiles, paying for home improvements or purchasing a new home outright
  • reducing assets by investing in a child's home
  • investing assets into exempt income producing property or other trade or business
  • investing assets into exempt tangible personal property
  • using available strategies to maximize the community spouse minimum resource allowance
  • making sure that the community spouse minimum monthly maintenance allowance is being used to its maximum extent.

Medicaid Recovery

Description of Medicaid Estate Recovery
Federal law allows states to recover money spent on behalf of the Medicaid beneficiary after that beneficiary's death. Recovery concentrates on what Medicaid considers an "estate." For most purposes, the only estate asset remaining at death is the personal residence.

Each state approaches recovery differently. In some states, recovery is only executed if the personal residence shows up in probate court. In these states -- there are only 13 of them left -- a simple family living trust would likely prevent recovery. In other states, the definition of estate is expanded to include trusts or life estates and virtually any other property in which the deceased person had an interest. Typically, the state will wait until the last death in order to place a lien against the property. If a community spouse is living in the home, the state will wait until after she dies before applying its lien. In many states, if the community spouse outlives the Medicaid beneficiary, the state will not attempt recovery at all and will simply ignore it.

A few states have adopted a federal lien procedure called a TEFRA lien. This allows the state to place a lien against the home as soon as his state starts paying for Medicaid costs. In these states, there is little that can be done to protect the home from recovery. These liens cannot be applied if the spouse is living in the home or if certain other entitled individuals are living in the home.

In all states, Medicaid recovery does not occur if the home is worth less than a certain minimum limit established by the state. Also, if recovery produces an undue hardship, no recovery occurs pending a "hardship hearing" with the state.

How Medicaid Views the Personal Residence
Almost all states allow the personal residence to be abandoned in favor of another living arrangement if the Medicaid beneficiary signs "an intent to return home." There may be some long term restrictions on this intent, meaning that after a certain period of time some states may question whether the beneficiary really could return home and may require a doctor's examination to verify this.

The rationale for this rule is based on the idea that if a Medicaid beneficiary in a facility gets better, he or she has a place to live in. In many cases, it is wise not to sell the home if it is vacant but to either rent it out and allow the rental income to subsidize the facility costs or to simply leave it vacant or to have a family member live there free of cost. Sometimes, the recovery on the house is not significant enough to warrant selling it or perhaps the house can be refinanced to take care of the Medicaid bill and allow the family to retain ownership of the property.

Medicaid -- Transferring Ownership of the Personal Residence
For a single potential Medicaid beneficiary, transferring the ownership of the property to anyone other than the exempted individuals below will result in a penalty if Medicaid is applied for within five years of the transfer.

For a married couple, title on the property should be transferred to the community spouse -- the healthy spouse at home who is not receiving Medicaid. In a number of states, the non-Medicaid spouse can transfer the property solely in her name to someone else and as a result completely remove the home from recovery. In other states, this transfer will result in a gifting penalty for the nursing home spouse even though the nursing home spouse does not own the property. If the community spouse successfully transfers the home, this will still create a penalty for her with a five-year look back if she ever has to apply for Medicaid.

There are certain cases where the home can be transferred to someone else and it does not create a penalty. Here are the exemptions.

  • transfer to the applicant's spouse
  • transfer to a child who is under age 21 or who is blind or disabled
  • transfer into a trust for the sole benefit of a disabled individual under age 65 (even if the trust is for the benefit of the Medicaid applicant, under certain circumstances)
  • transfer to a sibling who has lived in the home during the year preceding the applicant's institutionalization and who already holds an equity interest in the home
  • transfer to a "caretaker child," who is defined as a child of the applicant who lived in the house for at least two years prior to the applicant's institutionalization and who during that period provided care that allowed the applicant to avoid a nursing home stay. Evidence of the care and the effort to keep the applicant one of a nursing home must be provided.

Common Strategies to Protect the Home from Medicaid
There are a number of strategies that can be used to protect the home from estate recovery. In those states that go after probate property only, anything that keeps the house out of probate will suffice. In other states, some common strategies include the use of irrevocable trusts or transfers before death, .

Most of these strategies involve giving away ownership of the home. This creates a penalty either for a potential Medicaid application or for someone already on Medicaid whose name was on the property. There are also a number of strategies to deal with this penalty. The reason for creating a penalty through an outright gift or a trust is to start the five-year look back. Another reason might be to get the property out of the name of an aid and attendance applicant.

Transfer of the property as a gift, thereby creating a penalty, can be reversed in almost every state. In other words, if the consequences of a Medicaid penalty outweigh the advantages of gifting the property, the title is changed back into the name of the Medicaid beneficiary in order to allow that person to receive Medicaid benefits. In case the Medicaid beneficiary is incapacitated, a proper durable power of attorney that includes gifting rights must be set up in advance while the person was competent to do this.

Sell the House and Use Half a Loaf
Selling the house is generally only an option if a spouse or another member of the family does not need to live there. Selling the house might be an option for a single Medicaid beneficiary. Selling the house should be weighed against keeping the house as an exempt assets due to the Medicaid beneficiary signing an intent to return. The amount of recovery against the house depends on how much Medicaid has to pay for the beneficiary. If this is a sizable monthly amount it could add up quickly. Under these circumstances, over a period of a year or two, recovery could eat up the value of the home. If this is the case, the possibility of selling the home sometime prior to applying for Medicaid or shortly after applying for Medicaid should be considered. If the Medicaid obligation is not significant, perhaps the family could be satisfied with a recovery against the home.

Funds from the sale of the home will disqualify the Medicaid beneficiary until he or she has spent down to less than $2,000. However, a half a loaf gifting strategy could be used to transfer approximately 50% of the funds to someone else. This strategy might make sense for these reasons.

  • Anticipated recovery against the house -- which is currently exempt -- will eat up its entire value fairly quickly
  • Selling the home while the owner is alive takes advantage of the capital gains exclusion and reduces or eliminates the taxes owed on capital gains

Medicaid Recovery Where the Community Spouse Outlives the Nursing Home Spouse
In many states, if the community spouse is alive after the Medicaid beneficiary dies, the state will not attempt recovery even after the death of the community spouse. The home is always protected from recovery as long as the community spouse is alive whether he or she lives in the home or not.

In those states that attempt recovery, the community spouse, if healthy, can employ a number of gifting strategies. This is because Medicaid cannot apply a lien against the house while the community spouse is alive and living in the home. This does not mean that if the state is entitled to recovery, it cannot pursue civil action. Whether this happens on a regular basis we don't know.

When the Nursing Home Spouse Outlives the Community Spouse
If the community spouse dies prior to the nursing home spouse, under state intestate laws, the nursing home spouse will inherit the home. If the home is solely in the name of the community spouse, then the home is not considered a personal residence by the nursing home spouse and the home is no longer exempt and will count as an asset. This will disqualify the nursing home spouse for Medicaid.

An attempt could be made where the home is solely in the name of the community spouse to create a will that disinherits the nursing home spouse. Unfortunately, states do not allow spouses to disinherit each other and require that irregardless of any prior arrangements, a surviving spouse has a legal right to an "elective share" of the assets. In some states, this could be a third of the amount or possibly one half of the amount or some other number.

There is also a problem in those states where the community spouse transfers the home to someone else and that counts as a disqualifying gift for the nursing home spouse. Thus any gifting arrangements prior to death would disqualify the Medicaid beneficiary.

An immediate and sudden death of the community spouse cannot be planned for. An anticipated death, due to declining health, can be planned for. Strategies for dealing with this potential problem need to be addressed by a qualified elder law attorney.

Avoiding Recovery in Probate Only States
In those 13 states that only apply recovery through the probate process, any planning strategies that bypass probate will prevent recovery. This might include the use of a living trust or putting other people on the title in joint ownership with rights of survivorship.

It should be noted that if the state changes its definition of "estate" to include trusts, life estates or other arrangements, there has been typically no grandfathering allowing application of the previous rules. In other words, if the planning has been done to avoid probate and the state can now go beyond probate for recovery, little can be done to avoid this.

Irrevocable Trusts for Avoiding Medicaid Recovery
A properly structured irrevocable trust, meeting Medicaid requirements, that has title to the home, will avoid recovery. The problem is that transferring the home to the trust will create a penalty within the five-year period from the date of transferring title. The exception to this is in those states where the community spouse has sole title to the property and can transfer the home without affecting the eligibility of the nursing home spouse. On the other hand, the transfer of the property does create a penalty for the community spouse.

Promissory Note for Medicaid Recovery
The home could be sold on a promissory note and this effectively changes it from an asset to a loan and it is no longer considered an impediment to Medicaid qualification. Payments from the loan must be used to offset the care cost of the Medicaid beneficiary. This strategy used to be a very common one prior to the Deficit Reduction Act. The new rules pertaining to promissory notes make this strategy much more limited.

The term of the loan cannot exceed the life expectancy of the Medicaid beneficiary. For example, for a 90-year-old this might only be five years. This would make the payments very large and potentially unattractive for the family who is buying the property. All payments through the life of the loan must be equal. In addition, the loan cannot be canceled at death but payments must continue throughout the term of the loan into the estate of the deceased beneficiary which would make them subject to recovery. In those states that use probate for recovery, Medicaid could be bypassed by naming a beneficiary of the loan payments other than the state. The loan must be non-assignable meaning it cannot be used as collateral for another loan or purchased outright for cash.

The Ladybird Deed
This is a very clever way to transfer ownership in the property without creating a gift and a penalty. This deed is not available in all states but works very well in the states that allow it. The concept is quite simple. The deed transfers ownership of the property at the death of the Medicaid recipient. Any transfer of the home by a Medicaid beneficiary or by the spouse of that beneficiary, while that beneficiary is alive, will create a penalty. In this case, the transfer creates a penalty as well. But because it is at the death of the Medicaid recipient, it is irrelevant that a penalty is assessed. The deed retains ownership in the home for the Medicaid beneficiary and as such it is not considered a gift and no penalty is assessed by creating a ladybird deed.

Preserving Tax Breaks for Home Ownership If Title to the Property Is Changed
Gifting a personal residence prior to death or to sale by an owner who has resided in the home for at least two of the last five years results in a loss of significant tax breaks. If the personal residence is sold while the owners are alive, a lifetime capital gains exclusion of $250,000 for a single individual or $500,000 for a couple applies to the sale. Thus, if a portion of the exclusion has not been used previously, either $250,000 worth of equity or $500,000 is excluded from capital gains taxes of 15%. As an example suppose that a couple has established a basis in their home of $50,000 based on their original purchase price plus improvements and adjustment of any depreciation claimed for business use. Suppose that the home sells for $400,000. Without the capital gains exclusion, the couple would have to pay a capital gains tax of 15% of the difference between their basis and the selling price -- $350,000. This amounts to $52,500 in taxes. With the couples' exclusion there is no tax.

There is also tax relief if the children inherit the property at death. Instead of inheriting the basis in the property, the children will inherit the sale value of the property at the time of death. This is called the step up in basis and depending on when the property is sold, there is little if any capital gains tax due.

Any gifting strategies for the personal residence discussed in this manual, require a change in the title and this constitutes a gift to those persons on the title. Those persons receiving their portion of the value of the property by a gift lose the capital gains exclusion, unless they can establish personal residence by residing in the property for two of the forthcoming five years after their name is on the title. They also lose the step up in basis if they choose to sell the property outright.

The IRS recognizes certain irrevocable trusts called "grantor" trusts that if structured properly, can retain the capital gains exclusion and the step up in basis even though ownership has changed to the trust. We will discuss these arrangements in much more detail in the section on taxes.

The "Due on Sale Clause" if Title Is Changed
The due on sale clause was instituted in the beginning of the 1980s to protect banks from loan assumptions that could possibly preserve existing interest rates which were lower than prevailing rates. The banks didn't want to be stuck with an assumption with lower interest loans as interest on new loans was increasing substantially. Initially, there was no legal enforcement other than tort enforcement for the banks. A Supreme Court case in 1982 and a subsequent statute passed by Congress in the same year gave Federal legal stature to this provision. Here is the clause as typically written into every mortgage contract.

17. Transfer of the Property or a Beneficial Interest in Borrower. If all or any part of the Property or any interest in it is sold or transferred (or if a beneficial interest in Borrower is sold or transferred and Borrower is not a natural person) without Lender's prior written consent, Lender may, at its option, require immediate payment in full of all sums secured by this Security Instrument. However, this option shall not be exercised by Lender if exercise is prohibited by federal law as of the date of this Security Instrument.
If Lender exercises this option, Lender shall give Borrower notice of acceleration. The notice shall provide a period of not less than 30 days from the date the notice is delivered or mailed within which Borrower must pay all sums secured by this Security Instrument. If Borrower fails to pay these sums prior to the expiration of this period, Lender may invoke any remedies permitted by this Security Instrument without further notice or demand on Borrower.

This provision creates a problem for transferring title in the home when there is an existing mortgage lien on the home. It is becoming more common nowadays for seniors to borrow against the equity in their homes because many seniors don't have the income otherwise to pay their bills. The most common types of loans are home equity lines of credit or reverse mortgages. But, we are also seeing more and more seniors refinancing their homes outright to get at the equity.

Transferring the home into a trust or even retitling it requires permission from the mortgage company or bank. By the way, FHA and VA loans do not have these provisions but they do have a requirement that anyone assuming the loan must go through a credit check and be approved prior to allowing the assumption. Living trusts are specifically excluded from this provision and can be used as a way of shifting the title. Unfortunately, living trusts are of little value in the type of planning that we do for Medicaid or VA benefits.

If there is a mortgage lien on the property, this may prevent implementing some of the strategies that we have discussed. On the other hand, as long as the original titleholders names remain on the property, there should be no reason to prevent putting other names on there as well. However, the clause does require permission, even for a partial transfer of interest in the property.

In some cases, triggering the due on sale clause might be an acceptable practice for certain strategies. It is not illegal to trigger the clause, it only gives the mortgage holder the right to demand full payment or eventually foreclose. If the primary residence is going to be left vacant, and the intent is to sell, then triggering the clause might be the lesser of two evils in the planning process. If the sale were agreed to prior to transferring the property to a trust, the seller has 30 days before the bank can take any action. On the other hand, if the housing market is not good and it takes too long to make the sale, foreclosure could happen and that might be a worse consequence. In addition, transfer of the title to a trust might also affect the title insurance filed with the mortgage company.

Then there is the case of reverse mortgages. If there is a reverse mortgage on the property, when the property is vacated by the original individuals on the mortgage, the loan becomes due anyway. Oftentimes, the bank is willing to wait for 12 months in order to get the property sold. We are not sure what the consequences on a reverse mortgage are of transferring the title to an irrevocable trust when the house is left vacant as opposed to the procedure the bank goes through to call the loan when the provisions of the reverse mortgage are no longer met.