2010 Tax Basis Rules and Medicaid Planning - What happens to my Life Estate?

The estate tax changes in 2010 are not only playing havoc with estate plans, but asset protection planning for those concerned with long term care costs as well. I came across this informative article "Which Pre-2010 Medicaid-Oriented Transfers of Homes Get a Step-up in Basis under the Modified Carryover Basis Rules?" by Massachusetts attorney Brian E. Barreira.

For deaths in 2010 there is not an automatic step up in basis (see my prior post on the impact of 2010 estate tax law changes on basis).  Instead, a decedent' estate can add $1.3 million (for a single person) or up to $4.3 million (for a married person) to the basis of inherited assets.  Brian describes the situation as follows:

Under the applicable 2010 tax law, known as the modified carryover basis rules, an estate can opt for a step-up in basis for certain assets, and to see whether these are eligible, Internal Revenue Code section 1022 applies. The most common types of transfers of the home that were made for Medicaid planning purposes in the past were (1) joint tenancy with right of survivorship, (2) a reserved power of appointment in a deed, (3) an irrevocable income-only trust, which often includes a reserved power of appointment, and (4) a reserved life estate, use-and-occupancy agreement or informal understanding. To qualify for the step-up in basis, an asset must be owned under Section 1022(d) and acquired under Section 1022(e), so each type of transfer must be analyzed.

Internal Revenue Code section 1022 (d)(1)(B)(i) allows at least a partial step-up for some joint tenancies; (d)(1)(B)(iii) denies the step-up for a reserved power of appointment, presumably only in a deed. Section 1022(e)(2)(B) allows the step-up for some irrevocable trusts, including a power to alter or terminate the trust, which would seem to include a reserved power of appointment in an irrevocable trust. "

Brian cautions however that a transfer with a reserved life estate may have a different result for deaths in 2010:

It has been questioned whether a life estate is entitled to a step-up in basis. Several blog commentators have written that a life estate is not eligible for the step-up, but many of them seem to be parroting each other and not displaying their analysis. Section 1022(e)(3) seems to include a reserved life estate but not a use-and-occupancy agreement or informal understanding. The language in (e)(3) includes “property passing from the decedent by reason of death to the extent that such property passed without consideration,” and where the property passes to the remainderpersons upon the life tenant’s death, that description could include a reserved life estate. Further, under Massachusetts law, the life tenant has exclusive possession of the entire property during the life tenant’s lifetime, and may therefore fit the ownership test in Section 1022(d). Thus, it appears to me that a Massachusetts life estate can be eligible for a step-up in basis."

NAELA (National Association of Elder Law Attorneys) is currently seeking guidance from the IRS that basis under Section 1022 can be allocated to property transferred as a result of a life estate.  

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