Deducting Retirement Community Fees

Medical deductions for elderly clients.

or clients living in health care retirement communities, the Tax Court’s decision in Delbert L. Baker, 122 TC 143 (2004), provides additional flexibility in determining the portion of fees deductible as IRC section 213 medical expenses. CPAs should take note of the ruling.

Delbert Baker and his wife had an agreement with Air Force Village West Inc. (AFVW), a California retirement community, entitling them to lifetime residency. AFVW provided four levels of living accommodations and service, ranging from independent living to skilled nursing care.

Mr. Baker was a member of an ad hoc committee of AFVW residents using certified financial data provided by the community’s vice president of finance; he used the information to determine that approximately 40% of the couple’s monthly fees was attributable to medical care. Thus, the Bakers deducted that percentage of their costs on their 1997 and 1998 returns.

On audit, the service disallowed a portion of the Bakers’ medical deductions. Using a percentage allocation method (consistent with previous rulings), the IRS permitted only 19.01% of the monthly fees as a medical deduction.

At trial the IRS switched gears and claimed the allowable medical deduction, instead, had to be based on actuarial calculations, taking into consideration health care utilization and longevity. The Tax Court disagreed, calling the actuarial method “so complex as to defy full explanation.” It concluded the certified financial data the Bakers had produced was sufficient to shift the burden of proof to the service under IRC section 7491. The court cited the IRS’s 35-year history of allowing use of the percentage method.

While the Tax Court approved use of the percentage allocation method, it modified the approach used by both parties. Instead of allowing a percentage of the fees each resident paid, it held that the percentage had to be based on the number of community residents and a weighted average of their monthly service fees. Otherwise, occupants of larger units would receive a higher deduction based solely on the higher fees charged for such units, without regard to occupancy.

The court also denied the Bakers’ medical expense deduction for use of AFVW’s pool, spa and exercise facility. The court noted that the facilities were available to all residents and their families for recreational use, and the taxpayers had failed to establish the portion of their use for medical purposes. If such amenities are merely beneficial to a taxpayer’s health, no deduction is available.

Baker reaffirms that taxpayers entering retirement communities may continue to deduct certain of their costs without a costly actuarial analysis. Taxpayers now have a choice of either the preapproved IRS percentage method or the Tax Court’s modified percentage method, whichever produces the greatest tax benefit.

For more information, see the Tax Clinic, edited by Mike Koppel, in the December 2004 issue of The Tax Adviser.

—Lesli S. Laffie, editor
The Tax Adviser

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