Guide>Let's talk money>TAX DEDUCTIONS

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There is some relief in sight. Some of your one-time entrance fee and recurring monthly fees are tax-deductible. 

Disclaimer

These are general tax deduction guidelines. The amount of deduction allowed, if any, depends on the CCRC and the contract plan you selected. You should consult a tax professional to determine what deductions may apply to you.

Allowed deductions

Living in a CCRC is expensive! However, the IRS offers some relief. CCRC residents can offset some of their CCRC costs by claiming itemized deductions under IRC Sec. 213 (the amount that exceeds 7.5 % of AGI) for medical expenses that are implicitly included in their fees. These expenses are referred to as prepaid medical expenses.

The concept of prepaid medical deductions was affirmed by the U.S. Tax Court ruling in D.L. Baker v. Commissioner [122 TC 143, Dec. 55, 548 (2004)]. The 2004 decision allows your one-time entry fee and recurring monthly charges at Class A CCRCs to be classified as prepaid medical expenses.

This deduction only applies to CCRCs, where you pay an entrance fee and sign a lifetime contract where you pay a monthly maintenance fee until you die. This deduction applies to all Type A contracts, most Type B, and some Type C contracts. Living in a senior living facility or community does not qualify for the deduction. While living in an assisted living, memory care, or skilled nursing facility, you may deduct medical expenses paid to them; however, these facilities do not qualify for the prepaid medical deduction.

The amount that can be treated as medical expenses is not dependent on the level of health care services you received during a given year. Rather, the deduction is determined based on the CCRC's aggregate medical expenditures in relation to their overall expenses or revenue generated from resident fees. 

At the end of each year, the CCRC will issue a statement that shows the percentage of their operating costs that were spent during the year on medically-related operating expenses per resident. You can use this percentage to calculate the percentage of your CCRC fees that are considered prepaid medical expenses. This applies to the entrance fee (only for the year in which it is paid) and to the monthly fees (for each year in which they are paid).

Be aware: The entrance fee and monthly fee medical deductions may only be used for the tax year in which they were accrued; any unused deductions cannot be carried over to subsequent years. These are deductions from your earned income in the year they are used. Therefore, to fully benefit from the entrance fee medical deduction, you must have earned income that year that exceeds all your deductions. To fully benefit from the monthly fee medical deduction, you must generate enough taxable income every year.

Ways to create taxable income

Option 1

Convert some of the assets in your traditional IRA to a tax-free Roth IRA. Although a Roth conversion typically increases your tax burden significantly, the deductions from the CCRC medical expenses may be used to offset taxes on the conversion. If done properly, you will likely pay little or no taxes on the conversion; and the assets in a Roth IRA remain tax-free for the rest of your lifetime and the lifetime of your spouse. Future conversions may also be used to generate the income needed to take advantage of the recurring annual medical deductions.

An added benefit of the conversion of a Tradition IRA to a Roth IRA is the lack of required minimum distributions (RMDs) during your lifetimes. If the assets in your Roth IRA are not withdrawn during your lifetime and that of your spouse, then your beneficiaries will inherit these tax-free Roth IRA accounts; however, they will be required to deplete the account by the 10th anniversary of your death.

Option 2

Another option for creating taxable income is to take a large enough distribution from a traditional IRA or a tax-deferred annuity. to make full use of the one-time entry fee deduction and pay little or no additional income tax on that distribution.

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