ASK THE EXPERT: Life Estate Strategy
by Karen E. Klein w/ expert Lawrence E. Davidow

The problem: I understand that capital gains laws are going to change soon. Should I avoid, or seek an alternative to, a life estate as a means to protect my home from Medicaid?

The expert: Lawrence Davidow, certified elder law attorney, of Davidow Davidow Siegel & Stern, in Islandia, Garden City and Mattituck.

The rules: A life estate is created when you transfer ownership of your house to someone else (usually your children) but reserve the right to exclusive use and occupancy for the rest of your life. After Medicaid "look-backs" and penalties have run their course, the house is deemed protected from Medicaid, should you need it. After your death, the life estate is extinguished and your children own the house.

How it works: Under current law, when your children sell-the house, capital gains tax is assessed only on the increase in the property's value from the date of your death until the sales date, often a relatively short period of time. However, new rules are scheduled to come into effect in 2010 (or sooner) that measure the gain in the property's value from the purchase price, plus capital improvements to the sales price. So if you paid $10,000 for the house 40 years ago and added $40,000 in improvements over the years, your "tax basis" would be $50,000. If your heirs sold the property for $300,000, they'd have a $250,000 capital gain on which they would owe taxes (about 22 percent, including 15 percent federal and 7 percent state taxes).

The strategy: There are two major Medicaid planning techniques that can be used to save your house: life estates and irrevocable trusts Each technique carries certain tax consequences, which change often (even the 2010 law might be repealed in 20ll). Life estates are common but limit your ability to sell your home without causing other Medicaid and tax problems. And, if the capital gains tax rules change as anticipated, another benefit of life estates may no longer be available.

Consult with a certified elder law' attorney about long-term-care financing strategies, including the possibility of an irrevocable trust,which will not limit you from selling the house during your lifetime.

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