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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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The tax service you provide is crucial. What are the qualifications to use the AARP Tax Service?
Rick, can I assume that the last 3 months of Jane’s unreimbursed medical expenses were included as fully deductible on her 2023 return (subject to 7.5% AGI)? If so then wouldn’t the 2024 reimbursements for those same 3 months have to be included as taxable income in 2024?
Robert, thanks for reading and commenting. You ask an excellent question. The short answer is yes, but subject to the 7.5% AGI. Per IRS Pub 502:
What if You Receive Insurance Reimbursement in a Later Year?If you are reimbursed in a later year for medical expenses you deducted in an earlier year, you must generally report the reimbursement as income up to the amount you previously deducted as medical expenses.
However, don’t report as income the amount of reimbursement you received up to the amount of your medical deductions that didn’t reduce your tax for the earlier year.For more information about the recovery of an amount that you claimed as an itemized deduction in an earlier year, see Recoveries in Pub. 525, Taxable and Nontaxable Income.
IRS Pub. 525 gives the following simple example.
Example 34. For 2022, you paid $1,700 for medical expenses. Because of the limit on de- ducting medical expenses, you deducted only $200 as an itemized deduction. In 2023, you re- ceived a $500 reimbursement from your medi- cal insurance for your 2022 expenses. The only amount of the $500 reimbursement that must be included in your income for 2023 is $200, the amount actually deducted.
Her LTC policy is a reimbursement policy – she pays up front and gets monthly reimbursements for the insurer. All we saw was a 1099-LTC which provides total year disbursements. It doesn’t match payments with her bills. Assuming she returns next year, we will likely have to do some digging into her information to make sure we get it right.
this was really interesting and it points out how complicated tax regulations are. Also, kudos to you for volunteering.
Thanks Nick
I wonder why the house was gifted instead of inherited(step up basis) for your taxpayer. The parents could have allowed her to take the house for living and made the transfer upon death of the deed to take care of the tax hit. I’m sure there were other reasons involved, but advance planning can save taxes. I am also an AARP tax aide and thank all for their service to
the elderly and low income individuals.
Dan, thanks for reading and commenting. You ask a great question. I’m not sure why they gifted her the house. I’ve seen other families do this as the parents age. One reason I’ve heard was they were afraid that the aging parents might lose the ability to take care of the house. Some folks are unaware of the step up in basis on death, or that the gifted basis is the same as the giver. I’d be interested if any readers have experience in this and can provide better reasons for gifting?
I believe that in most cases it is an unintentional mistake. A lot of people do not understand “stepped up basis”.
There is probably a significant overlap in this group with the people who also ask how they can just withdraw all of their traditional IRA funds with zero tax (it’s my money).
Financial illiteracy is a real problem. Thanks Jonathan for helping to address this issue with Humble dollar.
Rick, As a TaxAide volunteer, thanks for pointing out how complicated things can become. The comment about the lady that had not filed a return for several years reminds me of a lady who came into our site and had not filed in several years. She said she had called the IRS and they told her she did not need to file as her income was very low. I prepared her federal and state return and showed her that she qualified for several hundred dollars of state credits and she owed no federal tax. She was the last client of our last day so I advised her to come back next year with the prior year info and we would get her the state refunds she was due. Another satisfied customer!
Harold, thanks for reading and commenting. We see many clients who have no federal tax liability or don’t have to file. but are eligible for a state property tax rebate (often $50). It does feel good to help someone get a refund!
I like reading these interesting tax situations you share on HD!
How quickly would AARP tax services handle an incorrect 1040 if it was brought to their attention? My battle with a non AARP experienced Enrolled Agent and the errors they make continues to march on. They completely ignore my concerns.
Olin, it’s frustrating as (fill in your own expletive) when your ignored. Sadly I have found that professional designations (EA, CFP, CPA, etc.) don’t guarantee good service. I hope you find a guy like Connor here that gives a hoot.
Olin, thanks for reading, It’s hard to give a specific answer to your question. It depends on the complexity of the return. There are things that the IRS considers out of scope for the VITA program. We have done amended returns for clients who had issues with paid preparers. It depends on the circumstances. One of the benefits of the VITA program is all returns are completely reviewed by a qualified preparer, so you are getting a thorough quality review. We find and correct mistakes that our colleagues make before the return is filed.
Thanks Rick! I have sleepless nights because of incompetent experienced tax preparers. I like that you mentioned that a second person reviews the returns. Is the VITA program only available during January through April 15?
Olin,
There are some sites that stay open until the extension period is over. You can search for a site by zip code at:
https://irs.treasury.gov/freetaxprep/jsp/vita.jsp?zip=07757&lat=40.3179397&lng=-74.0123851&radius=5
Olin. All the sites I have worked in are closed in April 15. Sorry
This kind of thing happens all the time, making your advice at the end of the article so very important. Situations like this should also be addressed in the letter of instruction that was discussed last week. Having said that, I kind of enjoyed these challenging tax returns as long as the client didn’t wait until April 15 to make an appointment.
Dan, thanks for reading and commenting. On our last day of tax prep I had a single mom who hadn’t filed a return during Covid. She thought we would only do her 2023 return, and wanted advice on what to do about the previous 2 years. They were fairly simple, and she was likely to get a few $100 refund, so we said we could stay late and knock them out. We had to remember how to handle the stimulus payments and a few other things. She was extremely grateful to get them filed. Our site lead told her that to pay us back she had to make an early appointment next year, and never skip a year going forward.
My cousins church hosts the AARPs tax service every year in Florida. People come in large numbers for the free service. Many have quite simple returns, but it’s a shame the tax code is so complicated that so much assistance is needed. There sure must be a better way.
Dick, thanks for reading and commenting. It’s true that many of the returns are fairly straightforward. Even with a smile federal return, the state return can be more complicated, especially with different health insurance rules, tax credits, senior programs, and property tax programs. Lower income seniors often rely on property tax rebates or freezes. The service also gives them free e-file and continuity for any carry-over items.
Wow! I thought my taxes were complicated.
It is wonderful that you perform so much skilled effort for free.
Thanks for the kind words. There are tens of thousands of folks who provide the same service each year. It is a great service.
So true. A CPA may have charged a couple thousand for this return.
Sadly, CPA’s also make mistakes on simple tax returns. I’ve been there!
Tax law is incredibly complex.
One of my wife’s cousin is a CPA who worked full-time in the tax department of a large corporation.
He would NOT file his own and his spouses Joint tax return.
He used a specialist in personal taxes.
Valuable lessons here. Kudos to you for applying your income tax knowledge to help seniors. Sounds like this particular one could have afforded a CPA who may have been able to be a bit more aggressive than your sponsoring organization likely allows. Does your nonprofit organization encourage its volunteer preparers to make referrals to CPAs in the more complex situations that arise with a person able to pay a tax preparer?
Thanks for reading and commenting. The IRS defines what type of tax situations we can and can’t address. There is an “out of scope” list we follow. There was nothing in here return that was out of scope, or beyond our training. When we did this return, I was the least experienced. The site lead had 16 years of volunteer tax preparation experience, and the other preparer had 20 years of professional (paid) tax prep experience. I would be very interested in hearing from any of the experienced CPAs who read the site on their interpretation of the case.
I haven’t worked on tax returns for over six years now, but her insurance company did her no favors for the upcoming year with the reimbursement of the 2023 months facility payments occurring in 2024. Now, if they reimburse timely throughout the current year, she’ll have over 12 months of reimbursed expenses for her 2024 taxes. Thus for this tax year those outlays will again need reconciling against the insurance form.
PS my initial thought for the 2023 discrepancy was she had an elimination period before getting reimbursed. So keep that in mind, folks, when it surfaces in your life.
PPS Spreadsheets are great for tracking home improvements that increase the basis of your home(s), but Quicken is even easier! 😀
Hi Stacey. The first thing I asked was if she had an elimination period but she had already passed that in 2022. In 2024 she will have 12 months of over $9k per month of medical expenses.
Yes she will have PAID 12 months (or maybe 13 depending on payment date for January 2024 or January 2025 invoicing.)
If I’m understanding the situation correctly the tax form will show more than 12 months, since it will include the delayed 2023’s reimbursement as well as 2024’s months. I understand she is a cash-basis taxpayer, thus it won’t be apples to apples when reconciling the form to her disbursements. It will have extra apples! 😀
All good, have fun with it in a year!