Protection of the House
California has one of the most aggressive estate recovery programs in the Country. The Medi-Cal Estate recovery regulations provide that after the death of a Medi-Cal recipient, the State has a right to repayment from:
“All real and personal property and other assets in which the decedent had any legal title or interest at the time of death (to the extent of such interest), including assets conveyed to a dependent, heir, survivor, or assignee of the decedent through joint tenancy, tenancy in common, survivorship, life estate, living trust, annuities purchased on or after September 1, 2004, life insurance policy that names the estate as the beneficiary or reverts to the estate, or any retirement account that names the estate as the beneficiary or reverts to the estate.”
There are several well established ways to avoid the estate recovery. Because most Medi-Cal recipients will own minimal assets on their death, other than their home (which is an exempt asset), this article focuses on protection of the family home.
For many people, setting up a "life estate" is the most simple and appropriate alternative for protecting the home from estate recovery. A life estate is a form of joint ownership of property between two or more people. They each have an ownership interest in the property, but for different periods of time. The person holding the life estate possesses the property currently and for the rest of his or her life. The other owner has an ownership interest but cannot take possession until the end of the life estate, which occurs at the death of the life estate holder.
Medi-Cal does not currently penalize the transfer of a home with a reserved life estate. (See DHCS Form 7077A). The transfer will be subject to gift tax, but unless the transferor has given away more than $5,000,000 in lifetime gifts, no gift tax is payable. On the death of the Life Tenant, there is a step up in basis. (See IRC section 1014).
Most importantly, the State of California does not recover against life estates. The current recovery regulations provide: “Where the decedent made an irrevocable transfer of a remainder interest in property with a retained life estate, the Department's claim shall not apply against the life estate or the remainder interest.” (22 CCR 50961(i)).
Irrevocable Income Only Trusts:
Another method of protecting the home from estate recovery is to transfer it to an irrevocable trust. Trusts provide more flexibility than life estates but are somewhat more complicated. Once the house is in the irrevocable trust, it cannot be taken out again. Although it can be sold, the proceeds must remain in the trust. This can protect more of the value of the house if it is sold. Further, if properly drafted, the later sale of the home while in this trust might allow the settlor, if he or she had met the residency requirements, to exclude up to $250,000 in taxable gain, an exclusion that would not be available if the owner had transferred the home outside of trust to a non-resident child or other third party before sale.
The estate recovery regulations provide: “The Department's claim shall not apply against property interests that the decedent irrevocably transferred before death.” (22 CCR 50961(j)).