Should the House be Put in an Irrevocable Trust?

The Facts: My elderly father is putting his house into an irrevocable trust and naming me and my brother as beneficiaries of the trust.

The Questions: If my father decides to move out of his house, will we be able to sell the house while my father is still alive? Would it be better if my father simply gifted the house to us now?

The Answers: The answer to your first question is “NO.” Unless you and your brother are also named as trustees of the trust, you will not be able to sell the house until it passes to you after your father’s death. The authority to sell trust property is held by the trustee named in the trust document, not by the beneficiaries.

Whether it would be “better” for your father to simply gift the house to you and your brother now depends upon his goals. If the goal is to qualify for Medicaid benefits, it does not matter if your father transfers the house to an irrevocable trust or to you and your brother outright. While both transfers will terminate your father’s control over the house (necessary for Medicaid purposes), both will also trigger a penalty period if the transfer takes place less than five (5) years before your father applies for Medicaid. Once the five years passes, assuming your father is otherwise eligible for Medicaid, who owns the house will be irrelevant.

However, if your father’s goal is to maximize your inheritance, whether he gifts you and your brother the house now or puts it in an irrevocable trust will make a difference. If the house is in trust at the time of your father’s death, you and your brother will become the owners of the house and will get a step-up in basis. This will likely avoid significant capital gains taxes when you sell the house.

However, if you are gifted the house during your father’s lifetime, your basis will be the same as your father’s. Assuming the house has appreciated a great deal since your father purchased it, your capital gains tax could be significant, effectively decreasing the size of your inheritance.

Another option open to your father is to transfer the house to an irrevocable trust and to retain a life estate. In this scenario, you and your brother will likely not incur any capital gains tax liability since you will get a step-up in basis when the house is transferred to you after your father’s death. In addition, retaining a life estate may make the transfer of the house into an irrevocable trust more palatable to your father because, although he gives up control over the house, his consent will be required to sell the house. As long as he is alive, your father will have an interest in the house and can block its sale.

There is, however, a downside to putting the house in an irrevocable trust with a retained life estate. Due to the passage of new Medicaid rules in September, 2011, if your father retains a life estate, upon his death, Medicaid can recover from you and your brother the value of your father’s life estate. For example, if the value of your father’s life estate is $60,000 and Medicaid made payments on your father’s behalf of $60,000 or more, Medicaid can assert a claim against the house after your father dies for the amount of the benefits paid out up to the value of the life estate. Unless the new recovery rules are amended or repealed, retaining a life estate will decrease the size of your inheritance by the amount of the benefits paid on your father’s behalf. Depending on the potential capital gains liability, this may make the life estate option more or less appealing to your father than the other options discussed above. It would be worthwhile to discuss this matter with an experienced elder law attorney and/or financial/tax adviser before deciding which option is “better” for your father.

This article first appeared in the March 8, 2012 issue of the Times Beacon Newspapers.

Linda M. Toga of The Law Offices of Linda M. Toga, P.C. is an East Setauket, New York attorney with a general law practice focusing on estate planning, real estate, marital planning, small business services and litigation.