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What Is a Life Estate?

TLDR

What You Need To Know

  • A life estate allows you to use your home until you die, then the property automatically transfers to your designated beneficiary
  • If a life tenant wants to sell, refinance or take out a second mortgage on the property, they must get permission from the beneficiary
  • Life tenants don’t pay capital gains tax unless they sell the property. And the remainderman doesn’t pay capital gains taxes until the home is sold

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This may not be a universal anxiety, but most of us don’t like to think or talk about dying. It can be an undeniably uncomfortable topic. So we’re going to focus on our legacies. For some of us, there is comfort in knowing we can leave behind property for our children or relatives to use and enjoy.  

You can leave your home in a will for a beneficiary, but things can get complicated with a will, especially if it’s challenged, and the process can drag on for who knows how long. To help avoid this scenario, you may want to consider a life estate deed or a life estate trust. 

If you’re interested in exploring a more certain path to transferring your property, you should consider life estates. We’ll explore their advantages and disadvantages, giving you enough information to decide if a life estate is right for you.

Life Estates, Explained

A life estate allows you to use your home until you die, then the property automatically transfers to your designated beneficiary (aka remainderman).

Life estates are useful for property owners who want to conveniently transfer real estate ownership to loved ones and continue using the property while they’re alive. 

For example, you can pass your home down to your child without putting them through the inconvenience of probate. But if you gifted them the home now, there would be tax implications – and you’d need to look for a new place to live. 

A life estate can offer the best of both worlds, giving property owners the right to control and use their home and land for the rest of their lives while guaranteeing their remaindermen receive full ownership immediately after they die.

Life estates are major, lifelong commitments that can’t be revoked. Before you create one, you need to know how they work and what to expect.

What is an enhanced life estate?

In most states, a life estate will look the same. However, there are a few states that recognize enhanced life estates. 

The difference between enhanced life estates and traditional life estates is that they allow the grantor (aka the life tenant) to retain control over the property (including the right to sell it) during their lifetime.

Enhanced life estate deeds (aka Lady Bird deeds) are available in five states: Texas, Florida, Michigan, Vermont and West Virginia.[1]

How Does a Life Estate Work?

When a property owner sets up a life estate, they agree to share ownership of the property with the beneficiary for the rest of their life, subject to certain conditions. 

A life estate establishes joint ownership between the current owner (aka the life tenant) and the beneficiary (the remainderman). As a life tenant, the current owner can continue living on the property or renting it out, and they are responsible for maintaining and insuring the property and paying property taxes.

Life tenants can use the property however they want, but they can’t make major decisions without the remainderman’s consent. If a life tenant wants to sell, refinance or take out a second mortgage on the property, they must get permission from the beneficiary. If both parties agree to a sale, for example, the proceeds will be divided between them based on actuarial tables from the IRS.[2]

When the life tenant dies, full ownership transfers to the remainderman. If there are multiple remaindermen, ownership interest will be divided between them.

What are the tax implications of a life estate?

As with any real estate transfer, a life estate deed will have certain tax consequences.

The IRS treats life estate deeds like other estates or gifts of real property. That means the property transferred by a life estate deed is considered part of the decedent’s estate and is subject to gift and estate taxes.[3]

Life tenants don’t pay capital gains tax unless they sell the property. And the remainderman doesn’t pay capital gains taxes until the home is sold. 

Can Medicaid take property in a life estate?

The law requires Medicaid programs to try and recover the cost of hospital stays, nursing home care and drugs covered by Medicaid. Medicaid estate recovery happens when a state seeks reimbursement from the decedent’s estate before the estate is disbursed to its beneficiaries.[4]

Because property in a life estate doesn’t go through the probate process, it’s generally not considered part of a decedent’s estate and is protected from Medicaid estate recovery.[5]

Can you remove someone from a life estate? 

The only way to remove someone from a life estate after the deed has been filed is by obtaining written permission from the life tenant and the beneficiary.

Pros and Cons of a Life Estate

Life estates can be an excellent estate planning tool. Used correctly, a life estate can benefit homeowners and beneficiaries. But life estates aren’t perfect. If you decide to use one, you should understand the drawbacks. 

PROS of a Life Estate👍

Simplifies estate planning 

A life estate creates an interest in a property for a beneficiary, so it doesn’t need to be included in a will.

Avoids probate process 

The probate process can be slow and painful, and the beneficiary won’t become the owner until the process is complete. Life estates aren’t subject to probate, so ownership is transferred immediately upon the grantor’s death.

Allows life tenants to continue to live in or use the property 

Life estates allow life tenants to continue living in their homes. Even though ownership is shared, the life tenant doesn’t have to worry about finding a new place to live.

Avoids surprises for beneficiaries 

Life estates make it clear who owns the home and what will happen after the life tenant dies, which can help prevent surprises and tension between relatives.

Protects property from creditors 

A life estate can protect the property from creditors. Even if the life tenant finds themselves in a difficult financial position, the home will transfer to its rightful owner, the remainderman.

Avoids Medicaid estate recovery 

The chances of moving to a nursing home or managed care facility increase as we get older. Life estates can shield property from Medicaid estate recovery, avoiding seizure by the state to pay for Medicaid costs and ensuring the home goes to the beneficiary.

CONS of a Life Estate👎

Life tenant surrenders some control 

Life tenants must give up some ownership rights, including the ability to sell, refinance or take out a home equity loan or home equity line of credit (HELOC).

Sale proceeds can be split if the property is sold before the life tenant dies 

If the life tenant and remainderman agree to sell the home, they split the money from the sale. The IRS determines how the proceeds are divided based on the life tenant’s age. (Hint: The older the life tenant is, the smaller their share will be.)

Beneficiary financial woes can affect the life tenant 

A life estate can help protect a home from a life tenant’s creditors, but it can expose the life tenant to liens from the remainderman’s creditors. If the beneficiary doesn’t pay their debts, their creditors could try and claim an interest in the home while the life tenant is living in it.

Life tenant assumes all responsibility for maintaining the home 

Even though the home is jointly owned by the life tenant and beneficiary, the life tenant is responsible for all maintenance and upkeep on the home, including paying for property taxes and insurance.

Can be difficult to change terms 

Life estates aren’t easy to change. Unless the beneficiary agrees to the change, it may not be possible to change any terms.

Life tenant can’t use the property as collateral for another loan 

Even if the life tenant has 100% equity in the home, they can’t use the property as collateral to secure another loan unless the beneficiary agrees.

How To Create a Life Estate Deed or Trust

Drafting a life estate deed is a fairly straightforward process with four major steps:

  1. Hire a reputable elder law attorney or attorney familiar with life estates and other types of estate planning.
  2. Weigh the pros and cons of life estates, explore every alternative and decide whether a life estate is the right fit for your estate planning needs. 
  3. Draft the deed, which must include in writing:
  •  The names of the grantor and the beneficiary (or beneficiaries)
  • The clear intent of the owner to transfer the property to the beneficiary (usually with the words “convey,” “grant” or “transfer”)
  • A legal description of the property (in most cases) 

Deed requirements can vary by state, so check with your attorney to see what specific language must be included in your deed. 

  1. Record and file the life estate deed with the county recorder or county clerk’s office.

Alternatives to a Life Estate

If you’re looking to pass down property without going through probate but aren’t sold on a life estate, there are other options to explore, including: 

  • Revocable living trust: A revocable trust gives a trustee the power to oversee your assets during your lifetime, and in the event of your death, distribute or manage those assets according to the terms of the trust. Unlike a life estate, you can make changes to a living trust at any time. And as the name suggests, revoke the trust altogether. 
  • Irrevocable living trust: Irrevocable trusts are similar to revocable trusts, only they can’t be altered without a beneficiary signing off on the change. Irrevocable trusts offer the grantor less flexibility than revocable trusts but may offer potential tax benefits and more protection against creditors.
  • Transfer On Death deed (TOD): A TOD deed avoids the probate process by transferring property ownership directly to a beneficiary upon the grantor’s death. The key difference between a life estate and a TOD deed is that the TOD beneficiary does not have ownership or financial interest in the home until the grantor’s death. 

Determine the Fate of Your Estate

A life estate allows you to proactively determine the fate of your estate. Life estates can serve you and your loved ones in life and after death. Consider creating a life estate to create a more certain path to homeownership for the person or people you love.

  1. LegalZoom. “Using a Lady Bird Deed in Estate Planning.” Retrieved October 2022 from https://www.legalzoom.com/articles/using-a-lady-bird-deed-in-estate-planning

  2. Internal Revenue Service. “Actuarial Tables.” Retrieved October 2022 from https://www.irs.gov/retirement-plans/actuarial-tables

  3. American Bar Association. “Section 2036 of the Internal Revenue Code: A Practitioner’s Guide.” Retrieved October 2022 from https://www.americanbar.org/content/dam/aba/publications/real_property_trust_and_estate_law_journal/v51/01/2016_aba_rpte_journal_v51_no1_levy_section_2036_of_the_irs_code.pdf

  4. Medicaid.gov. “Estate Recovery.” Retrieved October 2022 from https://www.medicaid.gov/medicaid/eligibility/estate-recovery/index.html

  5. U.S. Department of Health and Human Services Office of the Assistant Secretary For Planning and Evaluation. “Medicaid Estate Recovery.” Retrieved October 2022 from https://aspe.hhs.gov/reports/medicaid-estate-recovery-0

ICYMI

In Case You Missed It

  1. Despite sharing ownership, the life tenant is responsible for property taxes, homeowners insurance and maintenance

  2. Common alternatives to life estates include revocable living trusts, irrevocable living trusts and Transfer On Death deeds

  3. Life estates protect property from Medicaid estate recovery and the life tenant’s creditors, though the beneficiary’s creditors can file a lien against the property

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