How much of the Entrance Fee paid to a Continuing Care Retirement Community qualifies as a medical expense deduction depends on several factors. These factors cannot be determined by the taxpayer or the taxpayer’s tax advisor alone. The health care facility will need to provide information to its residents to help them determine the deductible medical expense and provide substantiation of the deductible amount for the resident’s tax records.
The health care facility must determine the amount of the deductible medical expense allocated to the entrance fee. The IRS and Tax Court have both used the “percentage method” to determine the medical expense allocation. Under the percentage method, the allocation of medical costs to total costs (medical expense allocation percentage) is determined by dividing the CCRC’s medical expenses by the CCRC’s total expenses. This percentage is then applied to the lifetime entrance fee of the smallest and least expense unit to determine the deductible medical expense portion of the entrance fee for all types of units.
The Tax Court provides some general guidance on how to calculate the deductible medical expense portion of a lifetime fee in Delbert L. Baker, et ux. V. Commissioner, 122 TC 143. First, total expenses for the denominator are determined. The starting point is total expenses for the entire facility. This would include cost for Independent Living Units, Assisted Living Units, Special Care Units and Skilled Nursing Facility. Total expenses for the denominator are calculated as follows:
Less: SNF Room and Board Revenue for noncontract patients, ALU noncontract patient fees, SCU noncontract patient fees, SNF ancillary services, Medicare and HMO billing for noncontract patients.
After total expenses are determined, the total medical expenses are determined. Total medical expenses for the numerator are calculated as follows:
Add: Operating Expenses Allocated to SNF, Operating Expenses Allocated to ALU and SCU, Interest expense allocated to SNF, ALU and SCU.
Less: SNF Room and Board Revenue for noncontract patients, ALU noncontract patient fees, SCU noncontract patient fees, SFN ancillary services, Medicare and HMO billing for noncontract patients.
Determining the costs to be included in both the numerator and denominator of the medical expense allocation percentage involve subjective judgments. The formula above serves as a general guideline. A complete analysis of the facility’s expenses is recommended in order to account for all expenses directly or indirectly associated with medical care.
Often units vary in size and the fees will vary accordingly. It is important to keep in mind a bigger unit with a higher entrance fee will not generate a greater medical deduction for the resident.
Any refund of the entrance fee received by the resident in a later year must be included in gross income in the year received to the extent a deduction was allowed for medical care.
If entrance fees are structured as a loan, the entrance fee will be treated as a loan for tax purposes and none of the fee is deductible as medical care.
The percentage of entrance fees allocated to deductible medical expense in various tax cases have ranged from 17% to 40%.
An HW&Co. Tax and Healthcare Professional can assist health care facilities in determining the proper percentage to be applied to entrance fees to determine the amount of deductible medical expenses included in the entrance fee.