Can Property in a Medicaid-Planning Trust Get a Step-Up in Basis Upon the Grantor’s Death?
Question:
Is there a way to create a grantor “irrevocable trust” that allows the beneficiaries to receive a step-up in basis of a home at death? If so, can this be considered a gift which falls under the 5-year look-back rule for Medicaid?
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Response:
Yes, though you’re mixing up a few different issues here. First, the trust does not have to be a grantor trust to get a step-up-in basis upon the grantor’s death. It just needs to be in the grantor’s estate for estate tax purposes, even though there won’t be any federal estate tax due unless the entire estate exceeds $12.9 million (a lower amount in some states), which is quite unlikely for anyone thinking about Medicaid. The easiest way to do that is to give the grantor a limited power of appointment exercisable through her will—commonly called a “testamentary” power of appointment. If the grantor retains no other rights, the property in such a trust will not be counted in determining the grantor’s eligibility for Medicaid coverage. However, as you suggest, for up to five years after funding the trust, the grantor will be ineligible for benefits due to the Medicaid transfer penalty.
Where the grantor trust rules are relevant, however, has to do with whether a homeowner who transfers her home to an irrevocable trust can take advantage of the section 121 right to exclude up to $250,000 of capital gain on the sale of her home in the trust during her life. Here the rules get complicated. The trust drafter must thread a needle between the tax rules that give the grantor enough control over the trust funds to qualify for grantor trust tax treatment, but not so much that she will be deemed the owner of the property by the state Medicaid agency. How this narrow path is navigated varies from state to state—Medicaid agencies take different stances on what is permissible and what is not. Drafters often give grantor’s limited lifetime powers of appointment (as opposed to the testamentary ones discussed above) or so-called administrative powers such as the right to substitute property of equal value, which under the Internal Revenue Code confers grantor status to the trust.
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