Retirement Community Fees Expected to Skyrocket Due to IRS Dispute

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The Internal Revenue Service wants to crack down on the billions of dollars in entrance fees held by retirement communities. In one case, Classic Residence by Hyatt, a for-profit community, might have to pay taxes on those entrance fees. In another, Mission Ridge, a not-for-profit community, might have to pay tax penalties based on interest profits made on these fees.

Steve Maag, director of assisted living and continuous care for the American Association of Homes and Services for the Aging, told HousingWatch that the two cases were almost opposites, but the net result of both cases would be additional costs for running these facilities and ultimately make the cost of operating these retirement communities more expensive.

So who will pay?
The baby boomers are now just starting to enter continuous care communities, of course. These communities have entrance fees that could range from about $250,000 to $2 million. The fees are refundable when someone leaves the community, either by death or a decision to move to a new location. The entrance fees are usually paid by the retiree from profits made on the sale of their primary residence. When the retiree enters the community he or she will start in an independent living arrangement but have access to assisted living and nursing home care all within the same community when, and if, needed.

In the case involving for-profits, the IRS claims Classic Residence by Hyatt underpaid its taxes by more than $107 million. The IRS says that Hyatt should pay taxes on these entrance fees, which can be held for 20 years or more. Hyatt's position is that these fees should be treated as interest-free loans. If the IRS is successful in its claim, then there are about 100 to 150 communities around the country that would fit in this category, Maag explains.

In the case of nonprofits, a different rule comes into place. These entrance fees are used as a liquid asset to back bonds. In the Mission Ridge case, the IRS believes the "arbitrage rule" should apply, which means if Mission Ridge earns more money in interest than it must pay on the bonds, taxes should be due on any profits from that interest.

Maag says that right now there are few profits made on the interest, but when the economy was in better shape, continuous-care communities were likely making profits on the interest they were collecting from these entrance fees. But if the IRS wins this ruling, then bonds for these communities would be considered riskier and would likely carry higher interest rates. Plus, the nonprofits would have to do extensive calculations to maintain the necessary arbitrage records for the IRS.

Maag says there are several hundred nonprofit communities watching the Mission Ridge case closely. This case started four years ago when an IRS auditor questioned the arbitrage issue during an audit. Since then, several other communities also have been questioned, he said, but all cases are being held up pending an internal IRS ruling on the Mission Ridge case.

Both cases could have a "dramatic impact" on the costs of operating continuous care communities, Maag says. He believes the IRS could possibly destroy the relative success of these critical options for housing retirees.

Just as we're getting ready to see an influx of baby boomer retirees, who have already lost so much in their retirement portfolios with the economic downturn, the I.R.S. could be making it much more expensive to find a place to live in retirement.

Lita Epstein has written more than 25 books, including "Working After Retirement for Dummies."
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