Here's a note I recently received from one of the other attorneys in our office:
Was just on the phone with a client who worked with you in 1989. He came back in when his Dad died in 2005 and again now that that his Mom has died at age 102. His Mom had been in a nursing home covered by MassHealth. The house was protected with a life estate deed and $200,000 in savings was protected in an irrevocable trust. Nothing is going through probate and everything will receive a step-up in basis. Thought you would like to know you did a great job in 1989 and despite all of the changes in the law, it still worked. (Also I was in 4th grade then, just saying, the firm does have longevity.)
While we'd always recommend that clients review their plans more often than every 15 years, given changes in laws and their application, we're very pleased that this plan that we put in place more than three decades ago still worked as intended. It protected the family home from MassHealth estate recovery and the assets in the trust from having to be spent down on the Mom's nursing home care. (You can read more about life estates here — it's our most popular blog post.)
What the "Step-Up " in Basis is All About
The step-up in basis my colleague refers to means that the house and any investments in the trust will not have any capital gains on their sale. Capital gain is the difference between the selling price of property and its basis. The basis is the purchase price plus, in the case of real estate, the cost of any later improvements. The tax on capital gains is approximately 20%, but can be a bit higher or lower depending on one's tax bracket.
For inherited property, however, the basis is adjusted to the property's value on the owner's date of death, which is often called a "step-up" in basis. If property is gifted during life, on the other hand, its basis remains unchanged. This is called a "carry-over" basis. In the case of long-held real estate, this difference can be significant.
Let's assume, in the example of our client, that his parents purchased the house for $50,000 and he sells it for $550,000. With a carry-over basis, he would realize a gain of $500,000 and a tax of approximately $100,000. With the step-up in basis, he will pay no tax on the property's sale.
This plan combined both tax and MassHealth planning to the clients' benefit. And it worked, despite some changes in the law, especially with respect to MassHealth's treatment of trusts. (A word just among us: We'd draft the trust a bit differently today than we did in 1989. Also, I'm sure glad that my colleague graduated 4th grade, high school, college, and law school, and joined our firm.)