Question:

I have elderly parents who are looking to update their revocable trust into an irrevocable one. They would just like to put their 2 homes (their primary residence & an investment property) together valued at about $3.3 million into it. I’ve gotten conflicting advice from 2 other lawyers on questions I have. (1) Can my parents continue to receive rental income from an irrevocable trust – which they partially need for living expenses? (2) In setting up the irrevocable trust, do they have an option/election to pay the estate tax up front, factoring in their $2 million exemption in Massachusetts? If so, would they pay tax on $1,300,000 ($3.3 million – $2 million exemption) X 3.2% = $9,600.

Response:

I’m assuming your parents want to put their properties into an irrevocable trust for Medicaid planning purposes. Assuming that that’s the case, yes, they can continue to receive the rental income. But the income would not be protected if they needed nursing home care, just the underlying properties If they both needed nursing home care or the survivor of them did, they would have to pay the net rental income to the facility.

Remember that a transfer to an irrevocable trust would make them ineligible for Medicaid nursing home coverage for the subsequent five years. So, either they need to keep enough funds out of the trust (or trusts, see below) to cover five years of care or you (and your siblings, if any) would need to be ready to cover any gap.

In terms of your tax question, your parents cannot prepay their estate taxes and they cannot both receive the rental income and remove the property from their taxable estates. They could use two separate trusts and draft the trust for their primary residence so that it’s removed from their estates since I assume it’s not producing income. But for capital gains tax purposes, you wouldn’t want them to do that. You would lose the potential step up in basis upon their death potential, causing taxes on capital gain far exceeding any estate tax that might have to be paid upon the survivor’s death.

Your parents can, however, create trusts that both protect the properties for Medicaid purposes (MassHealth in Massachusetts) and shelter $4 million from taxation between them. Your parents should create separate trusts that keep the property in the trust of the first to die from being included in the surviving spouse’s taxable estate. Depending on their respective values, either the two properties should be split between them or one be placed in your mother’s trust and the other in your father’s.

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