Grantor Trust Rules
My mother has a Medicaid income-only trust and her house is owned by this trust. She purchased the house in 1980 for $30,000. It's now worth $400,000. Does she lose the capital gains exemption of $250,000 if the trust sells the house now? Will the trust pay capital gains if the house is sold after her death? Does she get to keep her Star and Veteran’s real estate exemptions even though the house is in the trust?
First StepsFirst, let me say that you should have an attorney review the trust. Not all trusts are the same and the answer to your question depends upon what terms are contained in your trust. When we draft a Medicaid trust, we include provisions that make it a "grantor trust" for income and estate tax purposes. Such a grantor trust would allow your mother to reside in the premises and pay all the maintenance and carrying charges, included but not limited to homeowner's insurance, utilities and real estate taxes. As a result, she would still be entitled to the Veteran's and Star exemptions that she would otherwise be entitled to if the property were in her sole name. The trust could provide that all the income earned in the trust would be payable to her. Alternatively, the trust could also allow the income to remain in the trust or be paid to her children or others. Income would only be earned by the trust if the real property collected rents or there were other income producing assets like, but not limited to, stocks, bonds or bank accounts. In addition, there could be a retained power to change the trustee or the retained power to change the ultimate beneficiaries through a limited power of appointment. A limited power of appointment is a power usually reserved to the grantor to change the beneficiaries of this otherwise irrevocable trust. The exercise of the limited power is can be made in a separate lifetime document or in a last will & testament. This gives the grantor control of who the beneficiaries will be and also one of the provisions which make the trust a grantor trust. Grantor trust status would permit all trust income to be reported on your mother's personal tax return. Furthermore, she would still be entitled to the $250,000 capital gains exemption if the property is sold during her lifetime.
What's NextAdditionally, if the trust is deemed a grantor trust, upon your mother's death, there would be a 100% step-up in cost basis in the real property equal to the fair market value of the property as of the date of her date of death. This means that if your mother purchased her home for $30,000.00 in 1980, upon her death, the property would be re-assessed to the fair market value. Therefore, when the beneficiaries sell the property there will be no capital gains tax incurred, assuming the property does not increase in value from her date of death until sale. Not all trusts are created equal. You should consult with your Elder Law attorney to review the trust and be sure that its meets all your mother's requirements.