Understanding life estates may be essential if protecting the home (or other real property) is an important goal. Getting the concept down, however, can be a bit confusing. Confusion be gone! Read on!

Blame the English for our confusing real property law. I am convinced that the concepts involved in this article were invented in 1095 at Ye Whyte Horse on Thames Taverne four hours after closing time and some of the barristers had gotten a bit into their cups.

Lately, many have been asking about so-called “Lady Bird Deeds.” I’ll explain below . . . but you are going to have to read the whole article in order to understand.

First, take a look at other types of ownership . . . it might make understanding life estates easier.

Fee Simple

Most people think of real property ownership as fee simple. Someone with fee simple title completely owns the property. She can sell it, give it away, rent it, use it as security on a loan and do pretty much anything she wants with it (that isn’t otherwise illegal, of course). She is also responsible for paying the taxes on the property and any debts encumbering the property. The property is subject to the claims of her creditors. When the owner dies, the property passes through her estate (as directed by either a will or the state laws of intestacy).

Tenancy in Common

If two or more people own property the property is likely tenancy in common. Think of it something like a partnership among the owners. Each can use the property (unless they have a contract to the contrary). Each can sell his share, give it away, and use it as security for a loan. If one owner dies, his share passes as directed by his will or the laws of intestacy. Creditors can claim against his share. InGeorgia, a married couple is presumed to own property as tenants in common, although they can make other arrangements in a deed.

Joint Tenancy With Rights of Survivorship

This type of ownership might seem similar to tenancy in common, but it isn’t. Initially it looks like a tenancy in common, but if one owner

dies, the other owners take his share (divided among themselves). Sort of a “Last Man Standing” game because the property may end up completely owned (in fee simple) by the last surviving owner. Incidentally, in North Carolina, a married couple is presumed to own property as “tenants by the entireties” . . . which for purposes of this discussion acts the same as a joint tenancy with rights of survivorship (although they can opt out).

Now For Life Estates . . .

If one person owns the right to occupy and use property for her remaining life (she is called the “life tenant”) and the title specifies that the property passes automatically at the instant of the life tenant’s death (these folks are called the remainder interests . . . in the less gentle times of about 15 years ago they were called the remaindermen) the result is a life estate. Many folks call it “life time rights.”

While the life tenant has a right to live on the property or perhaps to collect rent on the property, she also has the responsibility of keeping it up and paying taxes on it.

Although theoretically a life tenant can encumber her life estate or sell her life estate, all she can do is dispose of or restrict whatever it is she owns . . . a life estate. No banker in his right mind will lend against a life estate because when the borrow dies . . . poof! . . . so does the banker’s security. The property passes free to the remainder interests. Same thing happens with respect to the life tenant’s creditors. Poof! Gone. Now don’t get excited . . . if the life tenant owned the property in fee simple and encumbered it before setting up the life estate the creditor isn’t going anywhere until someone pays up!

How To Set Up A Life Estate

Two ways. A fee simple property owner can set up a life estate for himself by conveying a remainder interest in the property to the intended remainder interests. The deed may say something like “I, Falstaff, the Grantor give Blackacre to Prince Hal, but retain a life estate in Blackacre.”

A way to set up a life estate for another person is for a fee simple property owner to convey property to another person as the life tenant and to yet another person as the remainder interest owner.  The deed may look like this: “I, Hotspur, convey Blackacre to Falstaff for life, with a remainder interest to Prince Hal.”

Will Medicaid Count a Life Estate for Eligibility Purposes?

In Georgia a life estate interest is a Medicaid-countable asset unless the property itself is not countable for some other reason (probably because it is the primary residence). In North Carolina a life estate is not countable . . . it simply renders the property regardless of value or size or type as a noncountable asset for Medicaid purposes.

Can the State Collect On Life Estate Property?

No. That is the beauty of a life estate. North Carolina only collects against probate property (and a life estate is not probate property . . . remember, it passes automatically at the life tenant’s death). The Georgia Department of Community Health says they can do it, but they never have and, unless the General Assembly drastically changes the law, they never will (Hint: read above about how a creditor goes “Poof!”).

Are There Other Medicaid Problems?

Yep. Remember that if you transfer something valuable it will not count as an asset for Medicaid (you don’t own it anymore, after all!). However, the transfer will raise issues of whether a transfer penalty should apply. If Falstaff transfers $100,000 cash it will not count because he does not own it; however . . . in Georgia it will count as a transfer penalty of about 20 months and in North Carolina about 16 months if Falstaff applies for Medicaid within five years of the transfer.

The problem with setting up a life estate is that most of the time something valuable is being conveyed. For example, if Falstaff is 70 years old, Medicaid uses an actuarial chart that shows Falstaff’s life estate to be worth about 70% of the value of the property, and Prince Hal’s remainder interest to be worth 30% of the property value.

If Blackacre is worth $100,000 and Falstaff sets up the life estate by transferring the remainder interest to Prince Hal, then Falstaff has transferred property worth about $30,000 (assuming Blackacre is worth $100,000). If Falstaff applies for Medicaid within five years he has a $30,000 transfer issue to deal with.

On the other hand, Falstaff could have sold Prince Hal the remainder interest and there would be no problem.

One planning strategy that is occasionally used is for Falstaff to buy a life estate. If he pays $70,000 for the life estate in Blackacre, he will pay fair market value so there will be no transfer penalty. Further, in North Carolina the life estate won’t be countable as an asset (it will be in Georgia unless it is his residence).

A Final Life Estate Problem

The last paragraph sounded pretty neat, hunh? Not so fast. The rules slow that up a bit by saying that if the life estate purchased was in property that was “the home of another person” then Falstaff would actually have to live in the property for at least 12 continuous months. If he doesn’t live there 12 months or more, there will be a transfer penalty on the purchase even though he may have paid fair market value. If the property was not the home of another person, Falstaff should be OK.

Flying to the Rescue (From Texas?): Lady Bird Deeds

I have no idea why they’re called Lady Bird Deeds or if Lady Bird Johnson used them (although her husband was one of Medicaid’s Founding Fathers).

A Lady Bird deed looks like a standard life estate deed at first glance, except that the Grantor retains the right to change his mind or give the remainder interest to someone else. “I, Falstaff, give Backacre to Prince Hal, but I retain a life estate in Blackacre and further retain the right to cancel this deed or to give the remainder interest to any other person so named.”

Would you pay Falstaff money for the remainder interest? Of course you wouldn’t. The remainder interest is worthless because Falstaff could always change his mind. On the other hand, if Falstaff dies without changing his mind, Prince Hal will automatically take Blackacre.

In North Carolina, because the remainder interest has no value Falstaff has not made a valuable transfer and there is no penalty. Further, on his death the property should pass free of estate recovery. Lady Bird deeds have worked fine for years. They do make me a bit nervous . . . they seem just . . . too easy. I’ll use them, but only if nothing else will work.

Georgia has an open season on Lady Birds. They don’t work. Period.

You have that uneasy feeling that you ought to be doing something . . . just not sure what. Perhaps Mom or Dad has been exhibiting some troubling health symptoms. As the oldest/only/closest child you know that it will be up to you to come up with a solution.

You’ve also been reading the news.

Once the 2012 elections are over and a new Congress is seated, Medicaid rules may likely tighten. It really will not matter which party comes out on top: It will become ever more difficult to qualify for this program as Congress authorizes and directs the states to revise rules.

The Forecast

Social Security, Medicare, and Medicaid are in trouble. Across the political spectrum, from secretaries Geithner and Sebelius to Mitt Romney and Paul Ryan, the alarm is being raised. The only thing the politicos disagree on is what to do. On April 24 the trustees of the Medicare program released their annual report with 3 different sets of numbers (“bleak, bleaker, and bleakest” according to Medscape Medical News).

So desperate is the government getting for money that cuts in Medicare reimbursements to nursing homes, aggravated by Medicaid cuts, will likely cause as much as 35% of nursing homes to reduce staffing – and North Carolina is the third hardest hit state (according to a study by the Alliance for Quality Nursing Home Care).

The financial crisis has set the stage for the problems, but all social programs directed to older population will feel intense pressure from the Boomers “coming of age” and having the nerve to live longer.

Some states are squeezing now. An excellent Wall Street Journal describes this in some detail.

Although the numbers discussed show the programs becoming insolvent at current levels within 10 to 15 years, do not be lulled into complacency:  Action will need to be taken very soon to begin to turn the tide.

While I have real misgivings about the way long term Medicaid is currently designed and believe that there are rational approaches to saving huge amounts, the current program and rules are all I have to use for the benefit of my clients.

So . . . What To Do?

Plan early. When the rules change, they almost always change prospectively, not retroactively. In other words, harsher rules will likely apply to planning strategies implemented after the new rules become effective.

Failure to adequately plan early runs not only the risk of being hit with higher rules hurdles, but leaving a family with fewer options if a parent’s health suddenly declines. There is a medical analogy here: The longer a bothersome problem is left untreated, the more intensive will be the final remedy (if one is even available).

So where does planning start?

Get educated!

First, become familiar with Medicaid. There are all sorts of resources online. I have written a “Plain English” guide to North Carolina Nursing Home Medicaid that is available online (fill out the online request form and I’ll even send you a paper copy – which also contains a valuable planning offer).

Learn about trusts. I have a number of informative articles posted on the Mason Law, PC website. There are also hundreds of articles on the web.

If you’re looking for something more comprehensive with planning guides and forms, tryElderLawUniversity. It is not free, but it is not too expensive either. Fair disclosure:ElderLawUniversityis my brainchild.

In May the Friends of the Asheboro Library and I will be hosting a series of three seminars that might get you started on planning. Click HERE for more details on these three seminars.

Get qualified help. Many of the news outlet articles I mentioned above urge people to get the help of a qualified elder law attorney. I know of at least one! On the other hand, there are other sources to find qualified help.

A good elder law attorney need not be certified, but a certified elder law attorney will be good. Check the North Carolina Board of Legal Specialization for board certified elder law attorneys.

The National Academy of Elder Law Attorneys (NAELA) is an organization representing almost all elder law attorneys in the US. The NAELA website has a geographically searchable directory. In fact, if an attorney is not a member of NAELA, he or she likely is not serious about practicing in the elder law specialty.

To recap:

• Don’t dither!
• Get educated!
• Get help!

Mom is in an assisted living facility.  Mom and Dad both receive Social Security (total is about $20,000).  Dad receives a federal retirement system pension of $35,000. Because the assisted living facility costs about $3,800 monthly ($45,600 annually) and they have other unreimbursed medical expenses (mostly drugs) of $3,000, Dad has liquidated half of a $100,000 IRA and plans to liquidate the other half next year (because he read one of Bob’s blog posts that it would be cheaper to liquidate an IRA over time rather than in one year).  Unless Dad can figure out some tax deductions, Mom’s and Dad’s taxes are going to hurt.

He just might be in luck. Depending upon Mom’s condition (and with a bit of planning) the assisted living facility costs might be deductible.

The Tax Stuff

Section 213 of the Internal Revenue Code provides a tax deduction for medical expenses to the extent medical expenses exceed 7.5% of adjusted gross income.

Example:  If a married couple had gross income of $50,000 and adjusted gross income of $45,000, they would be able to deduct some of their medical expenses not paid for from other source like insurance if the medical expenses exceed 7.5% of $45,000 (which is $3,375). If they have medical expenses of $20,000, then they would be able to deduct $16,625 ($20,000 – $3,375).

Back to Mom and Dad and their potential whopping tax bill. The trick is to determine if Mom’s assisted living facility costs qualify as expenses for “medical care.” Clearly nursing home expenses are deductible, but assisted living is a bit less certain.

Section 213 says that “medical care” includes “qualified long-term care services.” Hmmm. What assisted living expenses might be “qualified long-term care services”?

Qualified long-term care services (according to Code section 7702B if you happen to be a Tax Code Junky) include diagnostic, preventive, therapeutic, maintenance, and other care services required by a “chronically ill individual” pursuant to a care plan prescribed by a licensed health care practitioner.

Is Mom Chronically Ill?

The key is to determine if Mom is “chronically ill” and to make sure you have a written plan of care prescribed by a physician, nurse, or other licensed medical practitioner.

To be “chronically ill” Mom must either (i) be unable to perform at least two activities of daily living (called ADLs) for at least 90 days, or (ii) require substantial supervision in order to protect her health or safety due to cognitive impairment (in other words . . . dementia). ADLs include eating, toileting, transferring (in and out of wheel chairs and beds), bathing, dressing and continence.

So, if Mom is unable to perform at least two of the ADLs for more than 90 days OR she has dementia and requires close supervision, she qualifies as “chronically ill.” Make sure to get the written plan!

If Mom is in the assisted living facility because she needs a “little help” Dad could have some problems. On the other hand, if Mom cannot get in and out of bed, bath and eat by herself, or if she is perhaps in the locked Alzheimer’s unit, Dad will be able to use the assisted living facility costs as a potential medical deduction.

Deductible Assisted Living Facility Costs

To return to Mom’s and Dad’s situation above, they have $48,600 of medical expenses (the assisted living facility costs and the unreimbursed drug expenses). If Dad figures adjusted gross income of, say, $90,000, then he can deduct the expenses over 7.5% of $90,000 ($6,750).

The deduction of $41,850 ($48,600 – $6,750) should help out a great deal!