The Do’s and Don’ts
An Operational Guide to the Use of Irrevocable Medicaid Income Only Trusts
Cushing & Dolan, P.C.
Attorneys at Law
375 Totten Pond Road, Suite 200
Waltham, MA 02451
Todd E. Lutsky, Esq., LL.M
Important Trust Language and Drafting Traps to be Avoided
Surviving spouse, Mrs. Public, established an income only irrevocable Medicaid trust in 2007, naming herself and her oldest child as trustees. (Note very similar terms would apply for a married couple as well) The trust provides as follows:
(1) For so long as Mrs. Public is alive, income from the trust is payable to Mrs. Public.
(2) Under no circumstances is the Trustee permitted to pay to or use principal for Mrs. Public’s benefit.
(3) The Trustee, in its discretion, may pay principal to or for the benefit of the class consisting of Mrs. Public’s children of all generations.
(4) Mrs. Public reserved, in the trust instrument, the right to tell the Trustee to make a distribution of an equal or unequal amount of principal to or for the benefit of one or more of her issue during her life and or to make distributions to charities of her choosing..
(5) Upon Mrs. Public’s death, the property in the trust will be paid over to those persons selected from the class consisting of her issue and or charities, in equal or unequal amounts, as designated in a Last Will and Testament referring to this power executed after the execution of the trust.
(6) In the event the power is not exercised, the property shall be sold and the proceeds added to the balance of the trust assets and all trust assets to be divided into as many equal shares as there are children then living or children then deceased leaving children then living. In the case of a share allocated to a child such share will be paid out and distributed free of all trusts. In the event a child died then that child’s share would be held in trust for that child’s children rather than that child’s spouse and such share will be held in trust for the benefit of those grandchildren until no such grandchild is under 25 years of age.
Trust Paragraphs to be avoided:
- Purposes Clauses: These are paragraphs that indicate that the trust is designed for a reason such as to provide for donor to have as complete a life as possible and to ensure that the donor assets of the trust are to be used to keep the donor in the community as long as possible. This type of language could cause the assets in the trust to be countable for Medicaid Purposes. The standard to determine if an asset is countable for Medicaid purposes is if there is ANY WAY, regardless of how remote, that principal of the trust can be paid to the Donor then it must be paid and will be considered countable. Clauses like this one make it appear that principal is available and thus may result in a denial for Medicaid benefits. While this clause alone may not cause the trust assets to be countable it nevertheless should not be a part of your Medicaid Irrevocable Trust.
- Termination Clauses: These are clauses placed in the trust that generally allow the trustee under certain circumstances to terminate the trust and distribute the assets out to the beneficiaries. The problems with this type of language is that if all the trust assets can be distributed to the beneficiaries and there is no distinction made between the income and principal beneficiaries then one must assume that the principal could be distributed to the Donor of the trust thus making the assets countable for Medicaid purposes. Again if the principal can be paid to the Donor under any circumstances then it must be paid and will make the assets of the trust countable.
- Trigger Language: This is language that generally states that during any period of time that the Donor of the trust is not eligible for Medicaid benefits then the trustee in its discretion can distribute principal to the Donor for his or her care or for health and medical expenses including nursing home care etc. Even though the trust may have stated that the trustee cannot distribute principal to the donor in another paragraph, the state would likely say that you would not be eligible for Medicaid benefits because by not being eligible the principal of the trust can be paid out to you, thus you must use the trust assets and you would be denied benefits. While there maybe arguments on both sides of this equation this is certainly language that has not place in your Medicaid Irrevocable trust if you want to add certainty to the protection of your assets.
- Silence as to the Distribution of Principal: This is when a trust is drafted that states that income can be distributed to the donor but makes no mention as to whether principal can be distributed out to the donor or not. This is likely to cause the state to deny Medicaid benefits to cause every one to take a second look at this trust and the assets in it. The state has been denying benefits at all costs as of late and this would be another reason for them to do the same. Arguably, if there is absolutely no other bad language in the trust and specifically no language allowing the trust to pay principal to the donor then after you attend a fair hearing it may turn out that the trust assets are determined to be non countable and protected. However, why go through this extra ordeal when it can be avoided by simply adding a paragraph that prohibits principal from being distributed to the donor under any circumstances.
Question: Who would consider using these Medicaid irrevocable trusts?
Answer: While there is no hard and fast rule as to who can use these trusts, it is generally recommended to folks who have attained 60 years of age or older. In addition, you should consider using these irrevocable trusts if in fact one of your objectives in the estate and elder law planning world is to protect assets from the cost of long term care. In the event this type of asset protection planning is not important to you, then a revocable trust would be the recommended vehicle for your estate planning needs. Finally, if you happen to be under age 60 but have a diagnosed mobility related illness, then of course you could consider the use of these irrevocable trusts as well.
Question: Who can be the Donor of these irrevocable trusts and what does that mean?
Answer: The Donor is referred to as the individual who creates the trust. The Donor may also retain certain powers over the trust, most importantly, the power to remove and replace a trustee at any time for any reason, provided, however, that the replacement trustee can never be the Donor of the trust. This retained power by the Donor allows the Donor to retain a significant degree of control over the operation of the trust, even though the Donor does not serve as trustee. In addition, the donor will also be an income beneficiary of the trust.
Question: Who can be the trustee of these irrevocable trusts?
Answer: Often times, the Donor would like to serve as trustee of the trust thereby significantly increasing the Donor’s control over the operation of the trust assets during the Donor’s life. There is support for this position in Massachusetts where there is a case entitled Ledger vs. Department of Medical Assistance in which the Court indicated that, while this may appear to be an unappetizing maneuver, it nonetheless fails to contravene any rule or regulation. However, there has since been another case known as the Muriel Doherty case in which the Appellate Court in Massachusetts indicated that the irrevocable trust was not drafted properly and provided too much control to the Donor, whereby causing the assets of the trust to be at risk. Therefore, it is the recommendation of this author that, if the Donor of the trust has children or trustworthy family members, that they serve as trustee and that the Donor relies on his or her power to remove and replace the trustee, as mentioned above, in order to provide a comfort level when implementing these irrevocable Medicaid trusts.
Question: Do these trusts avoid the costs associated with the probate process?
Answer: An individual who passes away and owned assets in their own name, without a designated beneficiary, will subject all of those assets to the costs associated with the probate process. By establishing this irrevocable trust and, most importantly funding the trust with assets, will enable the assets that have been retitled to the name of the irrevocable trust to avoid the costs associated with the probate process. Always remember that if you just have a will this is the one document that must be filed with the probate court so if this is all the planning that you have done there is a good chance that you may not have even avoided probate.
Question: Do these irrevocable trusts protect assets from the costs of long term care and how long does it take?
Answer: Once assets have been transferred to these properly drafted Medicaid irrevocable trusts, the assets will be protected from the costs of long term care after the expiration of five years from the date of transfer. This is known as a five year lookback period for Medicaid eligibility purposes. This means that, from the date in which you would apply for Medicaid benefits, the state is entitled to look back at all of your prior transactions, bank accounts, investment accounts, etc., for the previous five years in order to see if there were any disqualifying transfers made during that period which would in fact prevent you from being eligible for Medicaid benefits. A disqualifying transfer is when a formerly available asset is transferred for less than fair market value to a place where it is no longer available for the nursing home. Once you have successfully made it beyond five years from the date of transfer to the trust, the state would then no longer be able to see such a transfer and therefore it would be protected from the costs of long term care.
Planning Note House Bill 6300: Just a reminder, this five year look back period is under review and the federal government is considering expanding it to be a 10 year look back period. If is this author’s suggestion that if you want to protect your assets that you start before the law changes.
Question: How is the transfer penalty period calculated and how is it different than the look back period?
To determine the penalty (or “period of ineligibility”), the value of the gift is divided by the average daily cost of private nursing home coverage (also known as the adjustment divisor) on the date of application.130 CMR 520.019(G)(1). For applications currently filed, the adjustment daily divisor is $300 (or $9,000 per month). If you gifted a $500,000 home the penalty would be 55.5 months ($500,000 )9,000).
Question: When does the penalty or period of ineligibility begin to run?
For transfers occurring prior to February 8, 2006, the penalty begins to run on the date of the transfer. 130 CMR 520.019(G)(3). In this case, notwithstanding the fact that the penalty period of 55.5 months has not yet run, this transfer would be fully protected under the 5 year lookback rules applicable to transfers into trust.
For transfers occurring on or after February 8, 2006, the penalty does not begin to run until the later of when the applicant is institutionalized and otherwise eligible. This basically means that the penalty doesn’t begin to run until after the donor is institutionalized and has less than $2,000. Therefore, YOU MUST WAIT 5 YEARS TO PROTECT ANY TRANSFERS.
Question: How do you value the real estate for MassHealth transfer purposes?
Pursuant to MassHealth Regulation103 CMR 520.007(G)(3)(a) the assessed value rather than fair market value pursuant is to be used for valuation and transfer period calculation purposes. This can be often times less than the fair market value which would result in a shorter period of ineligibility. However, remember this period of ineligibility does not begin to run on the date of the transfer.
Question: Which type of assets should a person retitle or transfer into one of these irrevocable Medicaid trusts?
Answer: First and foremost, IRA assets or any other qualified plan asset or retirement type asset, such as a 401(k) plan or a 403(b), should not and, in fact, cannot be transferred into these irrevocable trusts during life. In order to transfer one of these qualified plan assets into the trust, you would first need to withdraw the money from the qualified plan, thereby subjecting it to ordinary income tax liability and transferring only the amount net of taxes to the trust. Generally, this makes funding an irrevocable trust with such assets cost prohibitive.
The qualified plan type assets should now be used to live on during your life before looking to the trust assets for that purpose since the retirement plan assets would be outside the trust and therefore at risk for the costs associated with long term care. A common asset that folks like to transfer to the trust would be their primary residence. It is also possible to transfer rental property or vacation property to these irrevocable trusts in order to protect them from the costs of long term care.
Finally, people also wish to transfer their investment portfolios or a portion of their investment portfolios to these irrevocable trusts in order to protect them from the costs of long term care. All of those types of assets can, in fact, be transferred to the irrevocable trust without any adverse income or gift tax consequences.
Question: Can I continue to live in my home after it has been transferred to one of these Medicaid irrevocable trusts?
Answer: Yes, and you do not need any special language in the trust stating that you are permitted to live there the rest of your life. Since the home is in an irrevocable trust and since you control the trustee you have all the power you need to live there the rest of your life. For example if the trustee were to take any action with regard to the house or otherwise that you did not approve of or like, then you would simply remove the trustee and replace with another trustee. You have all the control you need to live there the rest of your life. In addition, you may also reserve a legal life estate in the deed that transfers the remainder interest to this trust. This reservation of a life estate also gives you the right to live there and preserve any real estate tax abatements that you might be entitled to.
Question: Can I sell my home after it has been transferred to one of these Medicaid irrevocable trusts and, if so, how does it work?
Answer: Yes, you can sell the home after it has been transferred to the irrevocable trust. Generally, the Donor simply tells the trustee that the house is to be placed on the market and sold. The trustee of the irrevocable trust would sign the purchase and sale agreement in order to complete the transaction. Selling the property from the irrevocable trust in no way complicates the transaction nor adversely impacts the buyer. Upon completion of the transaction, the buyer would cut a check made payable to the trustee of the irrevocable trust who then would in turn deposit the check into a bank account that is established in the name of the irrevocable trust. It is important to insure that the Donor does not receive the money personally, but instead the money is transferred directly into the irrevocable trust bank account. Finally, the house can be sold any time after it is transferred to the trust, even if it is during the initial five year period from the date of transfer.
Question: Does the sale of a home from the irrevocable trust re-set the Medicaid five year lookback period?
Answer: The five year lookback period is unaffected and, in fact, not reset by the selling of a home from the irrevocable trust, since nothing new was placed into the trust. The five year lookback period starts to run on the day an asset was transferred from an individual’s own name into the irrevocable trust and not the day the trust sells the property.
For example, if the Donor establishes an irrevocable trust and transfers the property into the trust on January 1, 2011, and then, on January 1, 2013, the trustee of the trust sells the property and in exchange the trust receives the proceeds, which are promptly deposited into the irrevocable trust bank account, that transaction will have no impact on the initial five year waiting period that began on January 1, 2011, when the home was transferred to the irrevocable trust.
In other words, the proceeds from the sale of the home, which are now deposited in the trust, will be protected from the cost of long term care in three more years, which represents the balance of the number of years remaining from the initial transfer of the home to the trust on January 1, 2011. Again, since nothing new was placed into the trust, there is no new five year waiting period created. In this case, the trustee simply reinvested the assets that were already inside the trust from real estate to cash or any other investment of the donors choosing.
Question: Can the trustee of the trust use the proceeds from the sale of a previous home to purchase a new home inside the trust?
Answer: Once the irrevocable trust receives the proceeds from the sale of the home and are deposited into the trust bank account, the trustee may invest those assets in any manner the trustee deems fit. In other words, the trustee may simply write a check to the seller of a home that you are interested in purchasing and the seller will prepare a deed transferring the property to the trustee of the irrevocable trust. Once again, this transaction of purchasing the home inside the irrevocable trust does not reset the five year waiting period.
As a practical matter, when one spouse passes away, it is not uncommon for a surviving spouse to downsize and sell the old primary residence and convert it to a condominium or some other downsized home. This transaction is completely permissible within the terms of the trust and again would not reset the five year waiting period for Medicaid eligibility purposes.
Question: Do I need the children’s permission in order to buy or sell real estate after it has been transferred to the Medicaid irrevocable trust?
Answer: No. You, as Donor of the trust, will simply instruct the trustee to place the home on the market for sale or to purchase a new home following the sale of the previous home. In the event the trustee does not comply, you, as Donor of the trust, retained the ability to remove and replace the trustee at any time and would thereby simply remove the trustee and put in a trustee who is willing to complete your requested transaction. Therefore, you do not technically need the children’s permission to complete the purchase or sale of a new home after it has been transferred to the irrevocable trust. Finally, in some instances, you, as the Donor, may also be serving as trustee, thereby eliminating this issue altogether.
Question: Will I still receive my capital gains tax exclusion upon the sale of my primary residence after it has been placed into an irrevocable Medicaid trust?
Answer: Yes. This capital gains tax exclusion amounts to the ability of married people to shelter the first $500,000 of capital gains on the sale of their primary residence while allowing single people to shelter the first $250,000 of capital gains on the sale of their primary residence. The rule simply states that you must have owned and used the property as your primary residence for two of the last five years in order to take advantage of this capital gains tax exclusion upon the sale of the property. Since the trust is designed as a grantor trust for income tax purposes, the individuals transferring the property to the trust will not lose their ability to take advantage of this capital gains exclusion once the property is sold from the trust.
The term “grantor trust” means that the Donors, or creators of the trust, will be considered the owner of the trust for all income tax purposes and, therefore, will be eligible to maintain their capital gains tax exclusion on the sale of the property from the trust. The trust is a grantor trust because the Donor has retained the ability to direct where the principal and/or income of the trust can go during the Donor’s lifetime and in accordance with Internal Revenue Code Section 674(a), this retained power is what makes the trust a grantor trust for income tax purposes, thereby preserving the capital gains tax exclusion.
Question: Can I transfer rental property into one of these Medicaid irrevocable trusts and, if so, what are the implications?
Answer: Rental property can be transferred to these irrevocable trusts and there would be no adverse tax implications of doing so. Remember, like the primary residence, this rental property can be sold and the proceeds can in fact be used to purchase another piece of property at any time during or after the five year lookback period. There would also be no adverse income tax consequences associated with any such sale. In other words, you would continue to pay all of the same capital gains taxes associated with the sale of rental property out of the trust as you would if you had sold the property from your own name.
In addition, you would retain the ability to pay the bills associated with the rental property, make decisions regarding rental increases, make decisions regarding removal of existing tenants and continue to collect and use the rent as usual. Remember, these were all decisions that were made by you prior to transferring the property to the trust.
Question: After rental property has been transferred to a Medicaid irrevocable trust, how is the rental income generated handled and who receives it?
Answer: These Medicaid irrevocable trusts are designed as income an only trust, which means that the trustee is obligated to pay out the income earned by the trust to the Donor and remember rent is income. In this regard, the tenant would write a check for the rent and make it payable to the trustee of the irrevocable trust. The trustee of the irrevocable trust must have established a checking account in the name of the irrevocable trust under its own tax identification number in order to deposit this rent check into the trust checking account. The rent check represents trust rental income in which the trustee is then obligated to write a check out of the trust checking account payable to the Donor of the trust, who in turn will deposit that check into his or her own personal checking account. You can also set the trust account up in a way that will automatically transfer the rental deposits to the donor’s personal checking account to be used as desired.
In other words, the rental income will end up in the Donor’s personal checking account through this two-step approach instead of directly, which is where the rental income use to go prior to the rental property being transferred to the irrevocable trust. The Donor is then free to spend that rental income on anything he or she desires, just like before the establishment of the trust.
Question: Do these Medicaid irrevocable trusts have to file separate income tax returns and, if so, does that result in an increased income tax liability?
Answer: If the trust has income then these trusts are in fact required to file a separate income tax return known as a Form 1041 as well as possibly a corresponding state trust income tax return. It is also important that the trust obtain a separate tax identification number for this purpose. In addition, having this separate tax identification number also helps maintain the integrity of the trust for Medicaid eligibility purposes. However, since the trust is a wholly owned grantor trust for income tax purposes, as described above, the trust will effectively not pay any separate federal income taxes. Instead, this grantor trust status causes the Donor to be treated as the owner for income tax purposes and essentially flows the income through the trust and causes it to be reported on the individual Donor’s income tax return, Form 1040, just like it use to be done prior to the establishment of this irrevocable trust. Therefore, these Medicaid irrevocable trusts are known to be income tax neutral, resulting in no increase or decrease in income tax liability to the Donor. The Donor will continue to pay the same tax as he or she did prior to the establishment of the irrevocable trust.
Question: Do the trust assets receive a step-up in basis for capital gains tax purposes upon the death of the Donor?
Answer: Yes the assets will get a full step up in basis upon the death of the donor. This step-up in basis rule can be important in reducing future capital gains tax liability associated with the sale of the property following the death of the Donor. A step-up in basis means that the cost basis in the hands of the beneficiaries following the death of the Donor would be equal to the fair market value of the asset received as of the date of the Donor’s death. Therefore, if the beneficiaries of the asset were to sell it shortly after the Donor’s death, it would result in little to no capital gains tax liability to the beneficiaries.
For example, if the Donor of the trust had purchased their home for $50,000 and had approximately $50,000 of capital improvements during the Donor’s lifetime, which would result in the Donor’s cost basis of the property being equal to $100,000. Let’s assume the Donor transferred this property to an irrevocable Medicaid trust and upon the Donor’s death the property was worth $400,000. Upon the death of the Donor, the beneficiary of this property would receive a cost basis equal to its fair market value of $400,000. If the beneficiary then sold the property for approximately $400,000, which is the fair market value, there would be no capital gains tax to be paid by the beneficiary.
This should be contrasted with individuals who opt to give away their home or other highly appreciated rental property to their children prior to their demise, as such a transaction would result in what is know as a carryover basis in the hands of the donee/beneficiary. A carryover basis means that the donee/beneficiary of the property transferred during life would be the same cost basis that it was in the hands of the Donor immediately prior to the transfer.
In our example, that would mean that the donee/beneficiary, the child, would have a cost basis in this real estate equal to $100,000. In the event the donee/beneficiary sold the property following the death of the Donor, there would be a capital gain equal to $300,000 ($400,000 – $100,000) and that would result in a capital gains tax assuming 20% federal 5% state and the 3.8% Obama care tax of approximately $86,400. The Medicaid irrevocable trust’s ability to conserve this step-up in basis benefit is extremely important. This basis step-up would apply to not only real estate, but any investment portfolios or stocks transferred to the trust that may have appreciated over time.
Question: Is there a gift tax liability associated with transferring a large amount of assets into these Medicaid irrevocable trusts?
Answer: There are no gift tax liabilities associated with transferring assets to these irrevocable trusts because the gifts to these are trusts are known as incomplete gifts for gift tax purposes since the Donor retains the right to designate the final beneficiaries of the trust in accordance with Treasury Regs. 25.2511-2C. In addition, no gift tax returns are required to be filed to report the transfer to the trusts, except if you wish to disclose the transfer to commence the running of a statute of limitations.
In these trust cases, generally no gift tax returns are intended to be filed since, as mentioned above, the trust assets will be included in the estate and will receive a step-up in basis as mentioned above. These provisions are essentially what enable individuals to transfer valuable homes, rental properties, vacation properties and/or investment portfolios to these irrevocable trusts without incurring any gift tax liability.
Question: Do I have to sell my assets inside my investment portfolio prior to transferring them into the trust?
Answer: No. In general, the funding of an irrevocable trust does not result in any income tax related issues whatsoever. In other words, when a trust is funded, it generally means nothing more than retitling the existing assets to the name of the trust. If you have an investment account at Fidelity, you are likely to receive a statement from Fidelity and it generally comes in your name, which is indicated in the upper left hand corner of the statement.
Once this Fidelity account has been successfully retitled to the name of the irrevocable trust, you, as Donor of the trust, will continue to receive these same statements from Fidelity, except in the upper left hand corner of the statement will appear the name of the irrevocable trust along with the trustee’s name and all of the investments that were listed on that statement prior to transferring it to the trust will, in fact, be there after they are transferred to the trust. Therefore, there is no adverse income tax consequences associated with retitling assets to the trust as nothing was sold prior to the transfer.
Question: How do I transfer real estate to the irrevocable Medicaid trusts and are there any adverse income tax consequences?
Answer: The funding of a trust with real estate is generally done through the preparation of a new Quitclaim Deed. The deed simply transfers the property from the individual name of the Donor to the name of the trustee of the irrevocable trust. Alternatively, the deed can be transferred to the trustee of a nominee realty trust in which the schedule of beneficiaries would state the irrevocable Medicaid trust as beneficiary. There will be no adverse income tax consequences associated with this transfer nor is there any gift tax liability due.
Question: Are there any investment limitations on the trustee of a trust?
Answer: The trustee of a trust can invest in all of the same investment options that would be available to an individual and therefore are not limited by having the assets invested inside a trust. However, the trustee should follow the prudent investment rule as a guide towards making investment decisions. The only caveat, of course, is that there are no individual retirement accounts owned inside of an irrevocable trust as mentioned above.
Question: Can the donor make investment decisions even if the donor is not serving as trustee?
Answer: Yes as most brokerage houses will allow the donor the limited trading authority so as to allow the donor, who may not also be the trustee, to make all the trading and investment decisions.
Question: Can these irrevocable trusts be changed in any way after they are created and, if so, how?
Answer: While the trust is irrevocable, it nevertheless can be changed through the use of a limited power of appointment. This is a power in the trust in which the Donor is granted the ability to change the beneficiaries of the trust but generally are limited to a class consisting of the Donor’s children of all generations and charities. This power enables the Donor to retain a significant degree of flexibility to adjust their wishes as life events unfold after the creation of the trust.
For example, a Donor may wish to leave a little more assets to grandchildren or perhaps may find that one child is doing extremely well financially while another child is struggling and may desire to reallocate the percentages in which the children are to receive assets, all of which can be done through the use of exercising this limited power of appointment. However, you cannot add a person as a beneficiary to the trust who was not already a member of the class of beneficiaries.
Finally, this limited power of appointment may also entitle the Donor to completely eliminate any child or grandchild from receiving any benefits and thereby offers a significant degree of control in the event a child during life does not cooperate.
Question: Can I add assets to the irrevocable trust many years later?
Answer: Yes, assets can be added to the irrevocable trust at any time after the trust has been created. However, the addition of assets to the trust will result in the creation of a new five year lookback period, but the lookback period will be associated only with those assets that were transferred. The creation of this new lookback period for those newly created assets will in no way affect the lookback period for previously contributed assets. In other words, if you had contributed assets to the trust five years earlier and only now wish to put additional assets into the trust, the assets that were put into the trust five years earlier will remain protected from the cost of long term care and this new lookback period will only apply to these newly added assets.
Planning note: House bill 6300 may change the look back period to 10 years so if the additional asset is added to the trust after the look back period has been changed to 10 years then this new 10 year look back period will be applied to any such transfer.
Question: Is it important to use one or two irrevocable trusts when doing this type of asset protection planning?
Answer: If you are single, then only one irrevocable trust would be needed. However, if you are married and the value of your assets exceed $1,000,000, or may exceed $1,000,000 over the balance of your lifetime, you should consider two irrevocable trusts. The reasoning behind two irrevocable trusts is to help you more fully utilize both of your federal and state estate tax exemption equivalent amounts, thereby serving to reduce your estate tax liability. In other words, these Medicaid irrevocable trusts can also help you reduce your estate tax liability while serving to protect your assets from the cost of long term care at the same time. A discussion on the reduction of your estate tax liability and how the trusts are designed to accomplish that is beyond the scope of this letter. If you have questions on this aspect of the article please do not hesitate to contact Todd E. Lutsky at 617-523-1555 for more information.
Question: Can the Donors borrow against any real estate that has been transferred to the irrevocable trust?
Answer: Once real estate has been transferred to these irrevocable trusts, generally you cannot borrow against the property any more. This is generally not a concern for many of the elderly folks who do this type of planning as they have paid off their mortgages and are not interested in going into debt any more. In the event you happen to have an existing mortgage on the property but wish to transfer it into one of these irrevocable trusts, the transfer of an existing debt to the trust will not trigger the due on sale clause but you will be prohibited from refinancing such debt. Therefore, it is important that any such encumbered property being transferred to the trust have a fixed rate mortgage for the life of the loan.
If borrowing against the property in the future is of importance to you, then it is recommended that you establish a home equity line of credit prior to transferring such property to the irrevocable trust. This will enable you to borrow against that equity line after the property has been transferred to the trust. Once the equity line expires, however, you would not be able to renew it.
Question: Can the Donor receive principal from the trust?
Answer: The trustee must be prohibited from distributing principal directly to the Donor as this is the paragraph that provides the protection from the costs associated with long term care. Generally, this is also not a problem for most of the people who use these irrevocable trusts as they are usually living off of their income. Remember, the income, such as social security, pensions, any interest and dividends generated from assets inside the trust, rent generated from inside the trust, or, of course, any IRA type assets which are outside the trust, are all available to the Donor after the trust is established. This flow in income generally is enough to allow the individual to continue to maintain the lifestyle they were used to prior to establishing the trust.
In the event extraordinary events arise and principal is needed in the future, the Donors of the trust generally look to assets that were left outside of the trust to spend first, more specifically the individual retirement account assets. Remember, these assets will remain at risk and therefore should be spent down first prior to any assets that are in the trust which would be protected from the cost of long term care and preserved for and used by the surviving spouse.
If an individual were to completely run out of assets outside of the trust and needed assets that were inside of the trust, however, there is a provision in the trust that enables the trustee to make distributions of principal generally to a class consisting of the Donor’s children of all generations, nieces, nephews, or siblings. Once such a gift has been made, the beneficiary of that gift can endorse the back of the check and give it back to the Donor/parent who, in turn, can deposit it into their checking account which is outside of the irrevocable trust and can be spent as desired. This transaction in no way impacts the balance of the assets inside the irrevocable trust. The asset that is now in the hands of the donor, however, would of course be at risk again for the costs associated with long term care.
Finally, in the event a child is not cooperative, remember the Donor reserves the right to change the beneficiaries of the trust during his or her lifetime thereby effectively eliminating or threatening to eliminate the non-cooperative child as a beneficiary upon your death. This power generally provides significant control to the donor over the assets in the trust.
Question: What if a Major Repair is needed on the Home Where Does the Money Come From?
Answer: The trust money can be used to maintain other trust assets. If you need a new bathroom or a new roof on your home or vacation home that is owned by the trust, the trustee is permitted to use money or investments that are inside the trust in order to make these household improvements. In fact it is important that such improvements are done in this manor and not paid by the donor out of personal non trust assets as that would look like a gift is being made by the donor to the trust and that would result in a new five year waiting period for those transferred assets. Remember, the donor does not own the real estate in the trust so he or she should not be paying for these home improvements but the trust can and should pay for them.
Question: Can you retain any real estate tax abatements that you may already be receiving after you transfer you home to these irrevocable trusts
Answer: Yes. However, the safest way to ensure this happens is to reserve a life estate in the deed to the primary residence prior to transferring it to the trust.
In the event you wish to learn more about how these irrevocable trusts operate or have questions on how the estate tax component can factor into the use of these trusts, please do not hesitate to contact Todd E. Lutsky at (617) 523-1555.
Securities offered through Securities America Inc., Member FINRA/SIPC and advisory services offered through Securities America Advisors. Armstrong Advisory Group, Cushing & Dolan and Securities America Inc. are unaffiliated. Representatives of Securities America Inc. do not provide legal or tax advice. The scenarios provided are for illustrative purposes only and not intended to represent client experiences of Armstrong Advisory Group or the Securities America companies. Please consult with a local attorney or tax advisor who is familiar with the particular laws of your state. 09/2014 AT #1003113.1