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Transferring assets into an Irrevocable Income Only Trust (“IIOT”) is becoming increasingly popular for Medicaid/Title XIX planning. The purpose of the IIOT is (1) to provide a source of income, (2) to protect and manage assets, (3) to obtain future Medicaid eligibility, and (4) to avoid the costs and time associated with probate.
IIOTs allow individuals to transfer their assets into a trust as protection in lieu of making outright transfers to their children. Under the terms of an IIOT, the person(s) establishing the trust (“grantor”) will receive all of the income produced by the assets in the trust for their lifetime.
IIOTs are commonly used to permit Medicaid to pay for the high cost of long-term care, once the Medicaid look-back period has passed. The look-back period is currently set at five (5) years. The look-back rule means that Medicaid will penalize an applicant who gives assets to others (including a trust) within five years prior to filing a Medicaid application.
If the grantor places the grantor’s home into the trust, then the trust agreement can specifically provide for the grantor to continue to reside in the home for the grantor’s lifetime.
IIOTs are irrevocable. The grantor cannot revoke the trust and reacquire the assets. Therefore, the assets are not available for Medicaid eligibility purposes after the initial 5 year look back-period. Once real estate is transferred to an IIOT, it cannot be mortgaged.
IIOTs also offer tax advantages. The grantor is treated as the owner of the trust for income tax purposes. This is valuable because the trust’s income tax rates are usually higher than the grantor’s income tax rates. The grantor also retains their Section 121 personal residence exclusion which can exempt $500,000 of gain on the sale of a couple’s ($250,000 for an individual) principal residence from capital gains tax.
Upon the grantor’s death, the trust assets obtain a “step-up” in value. This means that when the assets are distributed to the grantor’s chosen beneficiaries, the beneficiaries’ basis in the assets for income tax purposes will be the value of the assets as of the grantor’s date of death. As a result, the beneficiaries will avoid any capital gains taxes on the appreciation of the trust assets between the date of acquisition and the grantor’s death if the property is sold after the grantor’s death. Additionally, the IIOT can be drafted to include a special power of appointment for the limited purpose of including the trust assets in the grantor’s “estate” for estate tax purposes. A special power of appointment will also permit a grantor to change the beneficiaries who will receive the assets upon the grantor’s death.
The Irrevocable Income Only Trust can be a valuable tool in planning for Medicaid for long-term care, for the protection of assets that are intended to pass on to children or others and to avoid probate.
