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IRREVOCABLE INCOME ONLY TRUST (IIOT)
On February 8, 2006 the President signed the Deficit Reduction Act of 2006 (DEFRA). This law extends the lookback period to 5 years and delays the start date for any disqualification period to the date you enter the nursing home or the date that you have less than $2,000, whichever is later. This means that now, more than ever, advance planning is necessary for those who wish to protect their home and assets from the skyrocketing cost of nursing home care.
The benefits of transferring your home into an Irrevocable Income Only Trust (IIOT) is that it will avoid probate, give your children a step-up in basis (allows them to sell it tax free after your death), allow use of the $500,000 ($250,000 if single) gain exclusion, if the property is sold during your life, and protect it from nursing home costs.
This is the way it works; first a deed is prepared transferring the home to the trust. At this point there is a decision to be made. Do we want to transfer the entire property into the trust or, do we want to retain a life estate and transfer the remainder into the trust? If the parents are healthy and we are not concerned about nursing home placement and the possible five year disqualification period, we like to transfer the entire property into the trust. Retaining a life estate and transferring the remainder into the trust can substantially reduce the disqualification period. If a life estate is retained and the property is sold during the parent’s lifetime, they will receive a portion of the money and the amount attributable to the remainder interest will go to the trust and will be protected. The cash received by the parents will be eligible for the capital gain exclusion mentioned above but the cash will no longer be protected. Had the entire property been transferred into the trust at the beginning, the entire proceeds would be eligible for the gain exclusion and be protected from potential nursing home costs. This comes in handy when parents want to down-size and sell their home and buy a smaller one. In this case the trust would purchase the new house and the nursing home protection will continue.
Once the property is in the trust, everything goes on exactly as before. You still pay the taxes, mortgage and repairs. Your income tax reporting is exactly as before. This type of trust is considered “Defective” for income tax purposes. This simply means that the creator of the trust has retained enough of an interest in the property to be considered the owner of the property for income tax purposes. No trust income tax return is required. Everything is reported as before, on your individual income tax return. For a single family home, we are only talking about real estate taxes and mortgage interest.
Another benefit of using the IIOT is that you have increased flexibility in deciding how you want to leave your property after you are gone. You can make provisions to deal with the death of a child and possibly have it go directly to the grand-kids instead of the in-laws.
Choice of trustee can be a problem. It is our feeling that you and your wife should not be the trustee of your IIOT. We are concerned that naming yourself as trustee of your IIOT might be going too far and could affect the protection from nursing home costs. If you are not the trustee of your trust, you will lose any tax abatement that your are receiving from the town. The assessor’s office will not grant you an abatement unless you are at least one of the trustees.
The leading case regarding trusts is Cohen v. Commissioner of Div. Of Medical Assistance, 423 Mass. 399, a 1997 case that said that if the trustee has the ability to distribute ANY principal then, ALL of it is counted as an asset for MassHealth (Medicaid) purposes. After this case the IIOT became the standard trust for protecting the house. Under the IIOT the elder may only receive income and never any principal. Since the elder can not get the principal back, neither can the Division of Medical Assistance(DMA).
If the assessed value of your home is over $467,200 the penalty period for transferring your home into a trust will be capped at five years. Anything less than $467,200 will be less than 5 years. To calculate your penalty, the first thing you need to know is the assessed value of the home. Take the assessed value and divide it by $267 and that will tell you how many days you are penalized for. This figure of $267 is revised annually, each November. This means longer disqualification periods. The penalty period starts on the first day of the month that the deed was signed unless it is registered land then it is the first day of the month that the deed is recorded. The penalty period is a maximum of 5 years.
One word of caution, when dealing with penalty periods. If you are transferring a piece of property valued at more than $467,200, you must make absolutely sure that you wait at least 5 years and one day to file for MassHealth(Medicaid) benefits. It is my understanding that filing a long-term care application prior to the end of the disqualification period (5 years) can extend the disqualification period to the total numbers of days, as computed, without the benefit of the five year cap on the penalty period.
Now that the expanded estate recovery law has been repealed, the Irrevocable Income Only Trust is once again one of the preferred methods of protecting the home. Other options exist for protecting the home, including life estates. Everyone’s situation is different and there could be some exceptions available that would allow your home to be exempt without creating a trust or life estate. If you are thinking of doing this please seek the advice of an attorney who is affiliated with the National Academy of Elder Law Attorney’s. Our Massachusetts chapter has close to 500 member attorneys. While this is not a guarantee of perfect representation, it will get you in touch with an attorney who has affiliated him/herself with a group of attorneys dedicated to preserving the rights of the elderly.