Moving Into a Retirement Community May Mean a Big Tax Break
By Philip Moeller
The clouds are finally beginning to part for older retirees who want to move into a retirement community. Years of stagnant, if not declining, housing values have deterred people from selling their homes – the most common source of funds to pay the often hefty admission fees charged by some retirement communities.
Now, home prices and sales activity in many parts of the country have steadily improved. While some older seniors (the move-in age at many communities is from the late 70s to early 80s) undoubtedly have changed their minds about their future plans, the pent-up demand and rising numbers of seniors support the inevitability of a healthy recovery at many retirement communities.
Seniors considering or reconsidering such a community should be aware that they may qualify for hefty tax breaks if they move into a retirement community that offers assisted living and skilled nursing support as part of what are considered lifetime care benefits. If their children or other family members provide major financial support for entrance fees and monthly expenses, they also may be eligible for tax deductions.
Many seniors and their families are not aware of this tax benefit, according to Jerry Grant, executive vice president and chief financial officer of ACTS Retirement-Life Communities, Inc., which is based north of Philadelphia and operates 21 continuing care retirement communities in eight eastern and southern states. Grant says nearly all ACTS residents use the benefit once it's explained to them.
"In communities where a senior is contracting for services that include health care," he explains, "if the contract is obligating the provider for those services, and if the contract includes a non-refundable entrance fee, then that fee is viewed by the IRS as a pre-payment expense for health care services."
If entrance fees are fully or partially refundable, which is the case at many Continuing Care Retirement Communities, known as CCRCs, the expense deduction only applies to that portion of the fee which is not returned to the resident or his or estate, Grant explains. Some CCRCs have fully refundable entrance fees, but even more have a sliding scale, in which entrance fee refunds decline with each month of residency and disappear altogether in several years.
In cases in which fees are partially refundable, Grant says residents can take the full tax deduction at the time they pay the entrance fee. But either the resident or the resident's estate would be liable to return a portion of the tax deduction if he or she doesn't reside in the community long enough for the refund period to expire.
In addition to entrance fees, a portion of monthly residential fees at CCRCs may also be tax deductible. The logic underlying both deductions is that payments entitle residents to lifetime health care as part of their residential agreement, so a portion of their expenses really represents the cost of future health care benefits.
Some CCRCs have rental contracts for independent living arrangements, with "pay as you go" fees when residents need assisted living and nursing services. In those situations, only payments required for medical services would be tax deductible.
The percentage of CCRC payments that may be deducted from taxable income ranges between 30 to 40 percent throughout the country, Grant estimates. It varies by CCRC because communities have different expense structures. At ACTS communities, about 37 percent of entrance fees and 39 percent of monthly fees are deductible in 2013 as prepaid health care expenses.
ACTS provided a sample case study of how the tax benefit would work where entrance fees are not refundable. The example is for a couple paying a $250,000 entrance fee and monthly fees of $3,500, which provides them a two-bedroom apartment and access to assisted living and skilled nursing services should they need them. The couple is assumed to be in a 20 percent federal income tax bracket.
Of the $250,000 entrance fee, $94,050 (37.62 percent of $250,000) would be considered a qualifying medical expense. Only medical expenses above 7.5 percent of adjusted gross income may be deducted from income taxes, so the amount of the deduction will depend on the couple's taxable income and whether they have any other qualifying medical expenses. (Note: The threshold for medical expenses was raised to 10.5 percent in the recent tax law, but taxpayers older than 65 will be able to use the 7.5 percent cut-off for a few more years.)
For a couple reporting $100,000 of taxable income (from Social Security, pensions and investment earnings, for example), only medical expenses above $7,500 could be deducted. If the couple had no medical expenses other than their CCRC entrance fee, they could deduct $86,550 ($94,050 minus $7,500) from their taxable income. If they were in the 20 percent tax bracket, this would save them $17,310 in the tax year during which they paid the entrance fee.
On an ongoing basis, tax deductions for the monthly fees would work the same way. If the fees totaled $42,000 in a tax year (12 times the monthly fee of $3,500), $16,397 of that amount (39.04 percent of $42,000) would be a deductible medical expense. If the couple had no other medical expenses, the net value of the deduction would be $8,897 ($16,397 minus $7,500). That would be worth $1,779 in tax savings for someone in the 20 percent income-tax bracket. In practice, most people have additional medical expenses, so the CCRC tax benefit would yield larger tax savings.
Grant says if children or other family members provide more than half the total financial support of their parents, they can deduct a portion of the CCRC entrance fees paid for their parents. ACTS advises consumers to consult with their financial advisers or tax preparers to determine the best way to benefit from the tax deductions.
Despite this advice, Grant says many financial advisers and attorneys are not familiar with the medical tax deductions linked to CCRC fees. "Many of the tax preparers and accountants are more familiar with it," he says, "but they are not the ones who provide counseling in the upfront stage of this process."
More from US News:
9 Little-Known Ways to Pay Fewer Taxes
Books for Every Stage of Your Financial Life
12 Steps to Designing Your Financial Roadmap