Life Estates

For most people, their home is their largest asset.  It is also the one asset people are most sentimental about and the one they wish to protect the most. Most people want to insure that the home is protected and passes to their loved ones. One of the ways this can be done is by use of a life estate. 

A life estate is a type of interest in property whereby the holder of the life estate is entitled to use and/or occupy property owned by another.  An owner can give a life estate to another or the owner can retain a life estate in property that is transferred to another.  Both parties have an interest in the property. 

Although other assets can be transferred with a life estate, it is principally used for real property.  This article reviews a typical situation where the owner of real property wishes to transfer it but retain an interest to use and occupy it for the rest of his life.  This is frequently done when parents want to transfer their home to their children yet be assured that they can continue living there for the rest of their lives. 

The owner of the property transfers the property by a deed in which it is stated that he retains a life estate interest to use and occupy the property for the rest of his life.  The transferor, or donor, is then called the life tenant. The donee, who would obtain the property upon the death of the life tenant, is called the remainderman.  It is important to note that each has an interest in the property and once this interest is created it cannot be changed without the consent of both parties.

Transferring property with a life estate has many advantages, but is not for everyone and consideration must be given to other alternatives, the circumstances and intentions of the owners and those they wish to transfer to, and the consequences of such a transfer.  There may be some disadvantages.  Note also that a sale or mortgage of property is further complicated by the fact that all owners would be required to join in the mortgage or sale.  For example, if the life tenant wanted to take out a home equity loan, the lender would require that the remainermen also be liable on the mortgage.  In the event of a sale, both the life tenant and the remaindermen would be entitled to a portion of the proceeds of the sale.

Whenever one transfers property for less than fair market value, the value of the property transferred above what was paid by the receiver of the property is considered a gift.  Since the value of any interest real property transferred is undoubtedly above the annual gift tax exclusion amount ( $13,000 in 2010), the transferor must file a gift tax return even if no gift tax is owed. Careful consideration must be given to the gift and estate tax consequences of making this transfer and one should seek the advice of an attorney before doing so. 

One of the most significant advantages to transferring property while retaining a life estate is that if the property is not sold until after the death of the life tenant. Prior to 2010, if the property was not sold until after the death of the life tenant, the remainderman received the same step-up in basis of the asset as if he or she inherited it at the death of the owner, thereby reducing or eliminating any capital gains on the sale. Although this provision in the law was changed and the remainderman no longer automatically gets the step-up in basis, the executor of the estate of the life tenant may still be able to allocate appreciation to the beneficiaries or remaindermen. 

If the property is sold prior to the death of the life tenant, each owner would be entitled to a share of the proceeds.  Consideration must be given to the applicability of the capital gains tax exclusion for each seller.  This is important to keep in mind if the owners have any intention of selling the property prior to the death of the life tenant. 

Terms and limitations can be placed on the life estate and this must be considered when drafting the deed.  The life tenant is usually responsible for all taxes, insurance and maintenance on the property. It is because of this ownership interest and responsibility for the taxes that enables to life tenant to remain eligible for any real property tax exemptions, such as the STAR, Senior, Enhanced, Disabled and Veteran exemptions, he had on the property.  This is an important consideration and may be vital for someone to afford to remain living in the home.

Life estates are also very useful in the area of Medicaid planning.  By retaining a life estate interest in transferred property, the value of the transferred property is reduced. However, the life tenant is always entitled to a portion of the proceeds upon a sale and if the life tenant is a Medicaid recipient such proceeds will affect the recipient's Medicaid eligibility.  Further planning may need to be contemplated in such a case.  If the property is not sold, but is rented, the life tenant is entitled to the net rental income, which will be counted as income for Medicaid purposes

With recent changes in the Medicaid laws, life estates are being looked at in a new light.  Medicaid planners are now considering using assets to purchase a life estate in someone else’s home, thereby changing an available resource to an unavailable resource.  The ownership and tax consequences for both parties in  this type of transaction must be carefully analyzed before undertaking such a decision.

The complex area of the use of life estates in Medicaid planning is beyond the scope of this article.  As there are significant legal and tax consequences to transfers with life estates, these matters should not be undertaken without consulting with an experienced elder law attorney.

Copyright April 2010

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Joan S. Arbiter, Attorney at Law, P.C.
445 Broad Hollow Road, Suite 205
Melville, NY  11747
Phone: (631) 249-1976
Fax: (631) 982-1476

Melville, New York attorney, Joan S. Arbiter, helps families and individuals throughout Nassau County, Suffolk County, and the New York Metro Area to resolve legal issues in the areas of elder law, Medicaid planning, estate planning, probate, and real estate. Long Island communities she serves include Amityville, Commack, Dix Hills, Farmingdale, Hauppauge, Hempstead, Huntington, Babylon, Levittown, Massapequa, Melville, Mineola, Plainview, and Woodbury.