The Consequences of Life Estates
A life estate is a form of ownership in which property owners transfer ownership in their property, most commonly their home, while retaining the right to use and occupy it for the remainder of their lives. This type of ownership is used to avoid probate of the property and also may provide some protection of a home for purposes of long-term care (nursing home) planning.
When you have a life estate, you are called a “life tenant.” The people who own the future interest in the property are called “remaindermen” or “remainder owners.” Usually, the life tenant will continue to be responsible for real estate taxes, insurance, and ordinary maintenance costs for the property. If the property is rented, they will also be entitled to all income from the property. There can be more than one life tenant. If there are joint life tenants, for example, a married couple, they can retain a right to occupy the property until the last to die of the life tenants.
There are several considerations to think about when deciding whether to use a life estate as a planning tool. One issue is that you will no longer have sole control over the property. For example, you will not be able to sell or mortgage the property during your lifetime without the consent of all of the owners. An additional issue is that when you decide to transfer a future interest in your property and retain a life estate, you have given some ownership rights to your property away, usually to your children. If they encounter issues like divorces or creditors, this could create a title issue for your property. These problems will not affect your right to use the property during your lifetime but at your death the property will be lost to the creditor.
If the property is sold during your lifetime, this frequently will require the payment of significant capital gains tax by the remainder owners. Without the life estate most homeowners who sell will pay no capital gains taxes. If the home is sold after your death your heirs will generally pay no capital gains tax unless the home is sold for more than it was worth on the date of your death because of the step-up in basis rules. The step-up in basis rules apply whether there is a life estate or not. In addition, transferring property may create gift, estate, or income tax issues later on for you or for your children.
It is important to note that a transfer of a future interest in your home will be considered a property transfer for Medicaid purposes. This means that there will be a 60 month (5 year) look-back period during which this transfer would trigger a penalty period. Therefore, if you anticipate needing long-term care in the near future, transfering ownership in your home and retaining a life estate should only be done with a full understanding of all the issues. In addition, the value of the life estate might still be at risk during your lifetime.
A life estate can be a useful estate planning tool that can offer important benefits. However, it is important to consider the risks and benefits based on your unique situation. If you think a life estate may fit your circumstances, you should consult an attorney before moving forward so you do not encounter problems or surprises later on. If you have questions regarding a life estate and how it may fit into your broader estate plan, call us at 888-822-8778.