Fact Finding

Richard Connor

JANE IS A SINGLE woman in her 80s, sharp and friendly. She’s a former state employee with a solid retirement income. Unfortunately, she’s suffered some health issues in the past few years that have forced her to make serious changes.

I became aware of her issues when she came into the local AARP TaxAide site where I volunteer. She was the last client of the day, and the other scheduled client had rescheduled, so she got our full attention. It was a good thing, because her tax return required our best effort.

Complicated tax situations usually come down to an evaluation of the facts and circumstances, which are then measured against tax law, so tax-return decisions can be made. In Jane’s case, she’d sold her home in 2023 and moved into an assisted living facility. The move was precipitated by her declining health, including several falls.

From a tax perspective, her case was complicated by two issues. First, Jane had been gifted her home by her parents in 2000. The parents originally bought the home in the early 1970s for $17,000. Jane sold the house in August 2023 for $470,000. As a single individual, she was eligible for the $250,000 capital-gains exclusion on the sale of a primary residence. Even with this exclusion, she was looking at a large taxable gain.

The main challenge was determining the cost basis of the house. She had a list of improvements she’d made since she became the home’s owner. She also had documentation of her closing costs. The big unknown was the adjusted cost basis of the home when it was gifted to her.

The adjusted basis was the original purchase price, closing costs and any improvements her parents made. Jane was able to come up with a list of improvements made by her parents, including a new roof, siding and a new shed. After 20 minutes of questioning, Googling past prices and some informed guessing, we came up with a total of $25,000 in improvements that we felt were fair and reasonable. The additions to her cost basis reduced her capital gain to about $115,000.

The other complicating factor was her move into assisted living. It wasn’t a clean transition from her primary home. It took some time for a room to open up at the facility and for Jane to sell her house. While waiting, Jane had home health aides five days a week. Jane started paying for her place in assisted living in April, even though she hadn’t yet sold her house and wasn’t ready to move. Jane finally moved into the facility in August after she sold her house.

Jane’s documentation consisted of a receipt from the facility for about $80,000 and a 1099-LTC form. Her long-term-care plan was a reimbursement policy; she paid her costs out of pocket and was later reimbursed. The 1099 showed she had been reimbursed for about $27,000 in 2023. The nearly $50,000 discrepancy between her receipt and the reimbursement was confusing, because Jane stated she was sure she had been reimbursed for all her out-of-pocket costs. Figuring out what, if any, of her medical costs were tax-deductible took some doing.

Per IRS publication 502, qualified long-term-care services are considered allowable medical expenses, assuming certain criteria are met. We interviewed Jane to understand the circumstances of her medical needs. She confirmed that her doctor had documented her medical needs and prescribed a plan of care, including occupational and physical therapy. This information allowed us to determine that she met the IRS’s definition of a chronically ill person—someone who needed significant assistance with several activities of daily living.

Because she met the criteria, her room and board are considered to be part of her medical care and the cost is deductible. One confusing factor: how to handle the period of time when she paid for assisted living, but didn’t live there. Her room and board were almost $7,900 a month. We debated whether the three months that she paid for the room, but didn’t live there or receive care, were tax-deductible. During this period, she received care from home health aides, which is deductible. We felt taking a deduction for both the home health aides and the facility costs would be “double dipping.”

I recommended she claim five months of room and board, rather than the full eight. When she moved into the assisted living facility, she also paid for a higher level of care consistent with her medical needs, to the tune of $1,000 extra per month. We included this five months of extra care, along with her earlier seven months of home health care, in her medical deductions.

The deductible amount was those costs minus her reimbursements. We called the insurance broker to understand why the reimbursement was significantly lower than her documented costs. It took a while, but it turned out her reimbursements for the last three months of 2023’s assisted living weren’t paid until early 2024.

In the end, the combination of her home sale capital gain, reduced by her medical deductions, resulted in her paying $11,000 in taxes when she filed her return. She was concerned that her large capital gain could mean a tax bill of $40,000 to $50,000. We were happy we were able to help her sharply lower that amount.

There are several clear lessons for all of us. First, if you’re a homeowner, keep good records of your costs and any improvements. If you have parents who have lived in their home for decades, sit down with them, and start to build a fair and reasonable cost basis.

Second, if you have family or friends who have significant medical challenges that’ll likely result in expensive medical costs, help them put together a strong paper trail. Make sure they have a documented diagnosis and plan of care. Keep good records of costs, timing and reimbursements. These steps may help ease some of the financial pain come tax time.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on X @RConnor609 and check out his earlier articles.

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