These retirement villages can cost a bundle. Good thing there's a little-known tax break to help ease the costs.

FIGURING OUT WHERE YOU or your parents will spend your final years is among the most dreaded tasks in financial planning. For many folks, the No. 1 one priority is to stay at home — but that might not be realistic should significant health-care assistance be needed.

For affluent seniors, a continuing-care retirement community (CCRC) can be an attractive alternative. These centers offer a full range of services, from independent living to skilled nursing. People like them because they don't seem like a nursing home. If you strolled onto some of these campuses, you might think you were at a country club.

Unfortunately, the price tag for this lifestyle can make country club dues look like peanuts. Entry fees can run as high as $1 million, and ongoing monthly fees can set you back $5,000.

Clearly this isn't for everyone. But for those who could conceivably foot the bill, here's a bit of good news: A little-known tax break could significantly lower your costs.

The Appeal of CCRCs
Don't confuse CCRCs with assisted-care facilities, which for many are just temporary accommodations before moving to a nursing home. People who enter a CCRC buy into a long-term contract with the facility and will be there for the long haul. In exchange for a one-time entry fee and continuing monthly fees, the CCRC provides a residence and a range of medical and personal-care services onsite. The lowest level of care is independent living, which means no nursing care. As the resident's health- and personal-care needs become more acute, the level of care shifts to assisted-living services, long-term care with intermediate nursing services, and ultimately skilled nursing services, if necessary. The appeal: There's no need for residents to move from home to home as their needs change. This is truly a "rest-of-your-life" concept. Other names for CCRC-like arrangements are "Life Care," "Life Care Facilities," and "Life Care Communities."

Most CCRCs emphasize preventive health care by offering immunizations, physical exams, nutrition guidance, exercise, and physical therapy onsite. Primary health care, specialists, diagnostic testing, and various combinations of health-care and personal-care services may be offered in an onsite outpatient clinic, skilled care facility, or in the resident's home. Other services can be tailored to the resident's needs and typically include meals; housekeeping; transportation; and planned social, educational and recreational activities.

The physical layout of a CCRC can range from a spacious campus dotted with cottages, patio homes, duplexes, or townhouses to a high-rise apartment complex. The residential units can range from studio apartments to stand-alone homes with three or more bedrooms. The residences and surroundings can be quite upscale, even lavish. Depending on the community and the deal that's signed up for, the resident might rent or have an ownership stake in the real estate.

Fee Arrangements
The CCRC resident must usually pay a one-time entry or buy-in fee plus monthly maintenance fees thereafter. To say these charges can be sizable is an understatement. Naturally, a big factor in the monthly fees is whether residents are single or married (at this stage of life, two cannot live as cheaply as one). The resident's health status on day one also affects the initial monthly fee.

With a CCRC, there are usually three different types of contracts and fee arrangements to consider. They all include housing, some degree of residential services (such as yard maintenance and interior cleaning), and short-term and emergency medical care. Costs vary by the level of service.

So-called "extensive contracts" offer unlimited long-term nursing care with little or no significant increase in the usual monthly fee level. Because this option makes a high level of service available from the get-go, it's the most expensive type of contract. But it could prove to be the most cost-effective if lots of skilled nursing care is provided for a long time.

"Modified contracts" provide a specified amount of health care or long-term nursing care. If the level of care is stepped up, additional fees are charged.

Finally, "fee-for-service contracts" simply require residents to "pay as they go" for medical services and long-term care at prevailing rates. This is the least expensive option, but costs can ratchet up significantly if residents need to add on care services for a long period of time.

Because these contracts are complicated and involve lots of money (typically several hundred thousand dollars, at least), I strongly recommend that potential residents get advice from a CPA and an attorney before signing on the dotted line. In my opinion, two big areas of concern are: (1) whether the one-time entry fee entitles the resident to an immediate equity stake in the real estate where he or she lives ("yes" is obviously the right answer); and (2) what amount, if any, of the entry fee is refunded if the resident passes away not long after moving in. Seniors often overlook these two important issues, because they are busy focusing on the health care and personal care aspects of the deal. Now for the Tax Angle
The tax-saving idea here is that your parent (or you, depending on who is paying) can probably deduct part of the CCRC's one-time entrance fee and ongoing monthly fees as medical expenses. This is the case even if your parent currently lives independently at the CCRC and requires little or no care.

In other words, you're effectively allowed to claim a deduction for prepaid medical expenses, regardless of the CCRC resident's current health status (which may be fine and dandy). Since the fees we are talking about can be quite steep, significant writeoffs may be allowed despite the 7.5% of adjusted gross income floor for deductible medical expenses. That rule says a taxpayer can write off medical expenses only to the extent that they exceed 7.5% of his or her AGI. This prepaid medical deduction concept might sound too good to be true, but it's legit. In fact, some CCRCs mention it in their advertising and promotional literature.

For skeptical readers, I am happy to cite as my backup a 2004 Tax Court decision, Delbert L. Baker v. Commissioner. The Bakers started off in the independent-living category at an upscale California CCRC and resided in a two-bedroom, two-bath duplex that was equipped with a monitored emergency pull-cord system for medical crises. In addition, independent-living residents like the Bakers had access to medical services from the community's on-site health center. They could also take advantage of other on-site health-related amenities such as a pool, spa, and exercise facilities. The Bakers claimed medical deductions equal to about 27% of their first-year entry fee and about 40% of their monthly fees for two later years that were audited. These percentages were calculated by a committee of CCRC residents based on financial data supplied by the non-profit outfit that ran the community.

When the Feds audited the Bakers' returns, they allowed deductions equal to only about 19% of the monthly fees. The Bakers decided to take their case to Tax Court, which turned out to be a wise move, because they won big. Their only losing argument was an attempt to claim medical deductions for CCRC expenses allocable to the community's swimming pool, spa and exercise facilities. These types of expenses aren't deductible if taking advantage of the amenities is simply beneficial to your overall health as opposed to treatment for a specific medical condition.

Bottom Line: Taxpayer Victory
The Tax Court's 2004 decision is very good news for seniors, because it confirms that a CCRC resident can treat as prepaid medical expenses a significant percentage of the one-time entry fees and recurring monthly charges. Even better, the amounts that can be treated as medical expenses don't in any way depend on the level of health care services actually received by the resident during the year in question. They depend only on the CCRC's aggregate medical expenditures in relation to overall expenses or overall revenue from fees paid by the residents. Any CCRC worth considering should have estimates of these percentages available for potential residents to evaluate.

Last, let me clarify one important point. The IRS says a person must enter into a CCRC-like contractual lifetime-care arrangement in order to claim current medical expense deductions for amounts paid to the community that don't depend on the level of medical services actually provided to that person. So the tax break I've explained here isn't universally available to anyone who enters a retirement facility. (See IRS Revenue Ruling 93-72.)