A portion of long-term care expenses are deductible as medical expenses. The question taxpayers often ask is what portion of the fees paid to retiree communities, such as assisted living facilities or nursing homes, can be deducted. The Tax Court recently stepped into this issue and set some new rules.
When someone enters a nursing home or assisted living facility primarily for medical care, all the costs are deductible. But in most cases medical care is not the primary reason for admittance. Most people enter because they need assistance with some of the activities of daily living. Then, expenses are divided between nondeductible personal expenses and deductible medical expenses.
In the recent Tax Court case, a couple entered a continuing care residence community (CCRC). This is a community that offers independent living, assisted living, and a nursing home. Residents pay an upfront fee before admittance and are guaranteed admission to each level of care as it is needed during their lifetimes.
Here is how the Tax Court broke down the deductions for living in the CCRC in Baker v. Commissioner, 122 T.C. No. 8 (1994).
Expense allocation. The first step is to determine the portion of the CCRC’s total operating expenses that are spent on medical care. Most long-term care facilities provide residents with this information annually. The taxpayers in this case argued that the calculation should not include long-term fixed expenses such as interest, depreciation, and amortization. The Tax Court disagreed and ruled that all expenses should be included when determining the ratio.
Monthly fees. Each resident at these facilities pays a monthly fee that covers some medical care and other expenses. Normally, each resident in these facilities multiplies the medical expense percentage determined in the first step by his or her monthly fees. The result is the deductible amount.
The facility in the case based its monthly fees on the size of each resident’s unit. The court concluded that the size of the unit was an improper way to allocate the deductible medical expenses among residents. It ruled that the total medical expenses of the CCRC should be allocated on a per capita basis to all residents. Otherwise, residents with the larger units would get greater medical expense deductions regardless of their medical needs. So, the CCRC needs to calculate the share of medical expenses paid by each member based on the average weighted monthly fees of all residents for the year.
Extra facilities. The CCRC had a pool, spa, and exercise facilities. The monthly cost of these facilities has to be separately computed by the CCRC, according to the court. A resident can deduct his or her portion of these costs only when using the facilities “for the prevention or alleviation of a physical or mental defect or illness” as required by the tax law. If the facilities are used to improve general health, no portion of those expenses is deductible.
Non Refundable entrance fees. Most CCRCs require sizeable entrance fees. In some cases, these fees are nonrefundable. A portion of these fees effectively buys future medical care. These days, most CCRCs give residents a statement of the percentage of the fee that is deductible as a medical expense. The statement is based on actuarial studies that use the facility’s experience and the age of the new resident to estimate the medical percentage.
Refundable entrance fees. There is no medical expense deduction for any portion of a refundable entrance fee. Technically there should be other tax consequences to a refundable entrance fee, because the resident essentially is making an interest-free loan to the CCRC. The IRS, however, has not chosen to apply the interest-free loan rules to these fees.
Additional expenses. Of course, any additional medical expenses that you pay out-of-pocket are deductible under the regular rules, whether paid to the CCRC or another medical care provider.
CCRCs and other long-term care facilities must provide a lot of the information residents need to determine their deductions. Even after working through these rules, not every resident can deduct the expenses. The medical expenses are deductible only by taxpayers who itemize expenses on Schedule A. In addition, only the total medical expenses that exceed 7.5% of adjusted gross income are deducted. These rules mean that few taxpayers deduct medical expenses. Because deducting medical expenses is so difficult, taxpayers with significant medical-related expenses need to know the rules so that they can maximize their deductions.