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OBRA Restricts Access to Medi-Cal Funds

Part 2: Trust Restrictions Under OBRA
OBRA made significant changes in the regulations governing when and how assets placed in a trust will affect Medi-Cal eligibility. The Act defines trusts to include "any legal instrument or device that is similar to a trust but includes an annuity only to such extent and in such manner as the Secretary specifies." The definition leaves as much ambiguity as it resolves. Certainly traditional trust instruments, as defined by state law, are included. "Similar legal devices" may include Totten trust accounts, constructive trusts and "in trust for" accounts. Further, the nature and degree of applicability of the regulations to annuities is a question reserved to state regulatory authority.

OBRA regulations apply to any trust established by the applicant, a spouse, or legal representative (except trusts established by will), which are funded, in whole or in part, with assets of the applicant. The purpose of the trust is irrelevant, as are restrictions on distributions, restrictions on uses, or ability to exercise discretion under the trust. Where assets of the applicant are mixed with assets of others, OBRA applies to that portion of the trust that is attributable to the applicant.

Treatment of Revocable Trusts:
OBRA treats the corpus of a revocable trust as a resource, or asset, of the individual. Consequently, the trust corpus is included in asset calculations to determine the eligibility of an applicant. Further, any distribution from the trust to another individual during the lookback period -- 60 months when applied to trusts -- will be penalized as a transfer. Payments made from the trust to the applicant or spouse are treated as income, even if deferred or diverted to others.

Treatment of Irrevocable Trusts:
If the terms of an irrevocable trust place any portion of the trust corpus at the disposal of the applicant under any circumstances, that portion is treated as an asset for purposes of determining Medi-Cal eligibility. Any corpus or income that cannot be reached under any circumstances is treated as a transfer of assets and is subject to eligibility penalties for a period of 60 months following the date that access to the resource was foreclosed.

Payments from an irrevocable trust that are made to or for the benefit of the applicant are treated as income. Payments made for any other purpose, whether income or corpus, are treated as transfers and are subject to eligibility penalties for a period of 60 months following the transfer.

OBRA contains certain provisions specifically intended to prevent the use of so called "Medicaid qualifying trusts." As a consequence, it is no longer possible to shield assets while qualifying for long term Medi-Cal coverage. In an era of shrinking state and federal resources, this is an appropriate legislative response. But it is not without consequence for taxpayers. Given the uncertainty of existing state law, and the lack of official interpretation of OBRAs language, a conservative approach to asset protection strategies seems advisable. Since federal estate and tax laws do not complement OBRA regulations, it may be that individuals will be forced to choose between the somewhat conflicting objectives of wealth preservation and long term healthcare planning. The final segment of this article will review some of the asset protection techniques that are consistent with a conservative approach to OBRAs regulations.

Issue 7

Tax Angles of Selling a Home

When you sell your home, you will realize how clever you were to keep careful records about every improvement you made. The tax ramifications of the sale can be easily computed using the information in your files. first, you must determine the adjusted basis for the sale. This amount equals the original purchase price of the home (P), plus all improvement costs (I), less any casualty losses taken (C) and any gain on sale rolled over from a previous home into the house currently being sold (R). Adjusted Basis=(P+I)-(C+R).

Next, calculate the amount realized on the sale. This amount equals the sale price (S) less transaction costs (T), such as commissions, points paid on behalf of buyer, advertising, and legal fees. Amount Realized=S-T. Finally, determine profit/loss on the sale, which is the difference between the adjusted basis and the amount realized on the transaction. Any excess of the amount realized over the adjusted basis is profit, which may carry tax consequences. Fortunately, such consequences can be deferred and possibly avoided indefinitely.

Deferring the Tax Bill
The most common way to defer tax liability is to buy a new principal residence, which costs at least as much as the home you sold. The purchase of the new home must close escrow within two years -- either before or after -- the sale of the first home. Alternatively, if you are building your next home, you must build and occupy the new home within the same two year tie frame. Be aware that the IRS rigidly enforces the replacement period.

Aside from the occupancy requirement, the key is that the new home cost is at least as much as the one you sold, not how you pay for the new house. The rollover is not forfeited, therefore, when you make a small down payment on the new home and spend or invest the remaining proceeds of the sale elsewhere.

Avoiding the Tax Bill
When you decide not to buy another house, due to retirement or other reasons, the IRS might demand a healthy share of the equity built up in your home. Since there is no roll over, deferment is no longer possible. However, if you are at least 55 years old when you sell the home ad have owned and lived in the home for at least three of the five years prior to the sale, you qualify for an exclusion of up to $125,000 of profit.

The same $125,000 exclusion is available whether you are married, filing joint returns, or single. If you are married and filing separate returns, the limit is $62,500 for each spouse. The exclusion is available to married couples as long as at least one spouse meets all three requirements: age, ownership, and residency.

Unlike the rollover rule, you do not have to be living in the house when it sells to qualify for the exclusion. You can still avoid tax on the profit as long as you meet the three-out-of-five-year residency test.

You do not necessarily want to use the exclusion the first time it is available to you. In fact, that can be a costly mistake. This is a once-in-a-lifetime opportunity. You cannot use part of the exclusion to shelter $50,000 of profit on one home, for example, and later use the rest of it to avoid tax on the sale of another. Use any part of the exclusion and you use it all. Your best bet typically will be to save the exclusion until you sell what you expect to be your last home or until you can take advantage of the full $125,000. Do not worry about shortchanging your heirs by forfeiting the tax break if you die before using it; the tax on all profit that builds up during your life is excused when you die.

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