Entries in Asset Protection (1)

Saturday
Feb122011

The Value of an Irrevocable Income-Only Trust

Trusts were originally the tool of the wealthy.  Now they also serve the interests of middle class Americans as well!

Imagine this: you transfer your house to your children to protect the value of your house from Medicaid.  Then one of your children gets divorced or sued in a personal injury lawsuit, and your house is considered an asset of your child’s and gets taken through that proceeding. 

How do you prevent this from happening?  Well, in a word, create a TRUST.

Clients become worried when they hear the word trust.  What is a trust?  How will it work?  It’s this esoteric thing that clients find intimidating.  They think it’s just for the rich and famous.  Not true!  Trusts are the friend of the middle class as well.  I tell clients to think of trusts as a small business.  They have their own bank account and their own operating terms, as specified in the trust agreement.  Your lawyer will help you create the trust agreement and administer it in accordance with the law.

For asset protection purposes, if you create a trust, you will be foregoing your right to withdraw the principal of the trust, but if done right, you will receive income and a right to live in the house if you transfer a house.  You will retain enough other rights to the property of the trust so that if you were to die, the beneficiaries of the trust receive a date of death value on the trust property for capital gains purposes, instead of a cost-basis value of trust property. 

If you are thinking “huh” to that last part, consider this example:

Husband and wife purchase a house in 1950 for $45,000.  They make capital improvements to the house valued at $25,000.  The present value of the house in 2011 is $700,000. 

  1. If they GIFTED the house to their children for Medicaid asset protection purposes, the children would only receive a cost basis of $70,000.  If they sold the house thereafter, they would owe capital gains tax on $630,000.  At the present rate of 15%, this would result in a tax of over $65,000. 
  2. In this same scenario, if the parents transferred the house to a qualified trust, at the death of the parents, the children would receive a basis in the house equal to the value of the property on the date of death of the parents.  This means that no capital gains tax would be owed if the house sold for $700,000.  Additionally, if certain rights are reserved, the house can still qualify for certain special tax exemptions, including the VA and enhanced-STAR property exemptions, during the lifetime of the parents.  This is a huge advantage over a straight asset transfer!

So there are many benefits to an irrevocable trust.  Here they are:

  • Trust principal would be protected from creditors
  • Immediately upon transfer, assets would not count as a resource for Community Care Medicaid
  • Trust Income still available to support mom and/or dad
  • Trust funds remaining at death can pass automatically to named beneficiaries, without probate!
  • Date of death value of assets, instead of original cost basis

Of course, a trust is not right for every person.  There are also a few drawbacks.  They include:

  • Initial burden of transferring assets into trust
  • If either spouse needs Institutional Medicaid within the next five years, the trust would need to be unraveled and the entire initial principal at time of funding returned to the husband and wife
    o   Gift tax issues to children should they need to receive trust principal and transfer same
         to parents

To set up an Irrevocable Income-Only Trust to protect your or a loved one's assets, contact attorney Moira Laidlaw at (914) 767-0646 or email Moira at mlaidlaw@laidlawfirm.com.