Over the past months since COVID-19 turned our world upside down, I’ve done a few dozen webinars for prospective residents of various retirement communities across the country focused on planning for the future in an uncertain environment. One of the most common questions that I get during the Q&A portion of these sessions continues to be on the topic of tax deductions for entry fees and monthly fees at continuing care retirement communities (CCRCs or “life plan communities).
It’s been a while since I last wrote on this topic, and there have been a couple of changes since then relating to qualification for the deduction, so I thought this would be a good time to provide an update.
Understanding CCRC entry fee and monthly fee tax deductions
As you probably know, many CCRCs require new residents to pay an entry fee, which can range from under $100,000 up to several hundred thousand, depending on the community. Based on your contract type, some portion of the entry fee may be refundable should you move out of the CCRC or as a payment to your heirs upon your death.
Some people may not realize that residents of “entry fee retirement communities” may also be able to deduct a portion of that entry fee, and possibly a portion of their monthly fees, from their taxes as a prepaid medical expense. Again, the amount of deductibility is largely dependent on the type of residency contract held by the resident.
>> Related: A Primer on CCRC Residency Contracts
In order for any part of the entry fee and monthly fee to be tax-deductible, a portion of those fees must be accounted for by the community as a pre-paid healthcare expense. This is always the case with a lifecare contract (Type A) and, to a lesser degree, a modified fee-for-service contract (Type B). In some circumstances, such tax deductions may be available for a fee-for-service contract (Type C), if it can be clearly shown by the organization that some part of the fee(s) is being used to subsidize the cost of care delivered by the community.
Not applicable for refundable part of entry fee
It’s also important to know that only non-refundable portions of the entry fee can be used for tax deduction purposes. Any refundable portion of the entry fee should not be counted in the formula to determine the deductible amount. If a resident deducts any portion of the entry fee that is eventually refunded via a “return of capital contract,” then the refundable portion could later be taxable as income.
As a general estimate, a deduction equivalent to around 30 or 40 percent of the entry fee is not uncommon for lifecare contracts. A CCRC’s auditor or chief financial officer should be able to recommend an appropriate formula to help residents calculate the allowable deduction amount, often providing a written explanation each year before tax time.
Again, depending on which contract types offered by the CCRC and which one you choose, some portion of your monthly fee (also called a service fee) may also be tax-deductible. The percentage of each month’s payment that is deductible is often similar to the percentage that applies to the entry fee.
Recent tax law changes impacting deductibility
Under the tax law for 2020, individuals who itemize their taxes may deduct medical expenses exceeding 10 percent of their adjusted gross income (AGI). The actual deductible amount will depend on your taxable income and any other qualifying medical expenses. This threshold for medical expense deductibility went up this year — in 2019 it was 7.5 percent of AGI. To my knowledge, this is not scheduled to change in 2021.
Another change in recent years: The standard deduction was significantly increased by tax law changes in 2017. For tax year 2018, it rose from $6,500 to $12,000 for individuals, from $9,550 to $18,000 for heads of household, and from $13,000 to $24,000 for married filing jointly. In tax year 2020, for single taxpayers and married individuals filing separately, the standard deduction increased to $12,400. For heads of household, the standard deduction for 2020 is now $18,650, and for married filing jointly, it is $24,800 this year.
With these two tax law changes, fewer people are itemizing (instead of taking the standard deduction), and also fewer people will qualify to deduct CCRC fees than before. It’s important to understand that you can’t take deductions like the medical expense tax deduction if you file using the standard deduction.
However, for some people, it may still make sense to itemize at least in year one when they enter the CCRC because they could get a sizable deduction in that year from the entry fee. They could then switch back to taking the standard deduction the following year if necessary.
Also of note, if a CCRC resident’s adult children pay the entry fee, or some portion of it, the adult children may be entitled to take a tax deduction. However, other factors must also be considered, including the total amount of financial support they provide for their parents.
Talk to a tax professional
The information provided in this post is NOT intended to be tax or financial advice. It is simply information to consider when choosing a CCRC and contract type. You should always work with a qualified tax professional to help you analyze your unique tax situation.