What is a Life Estate?

What is a Life Estate?

A life estate is a type of property ownership that divides the control and ownership of a property. The person who creates the life estate for their home and assets is known as the “life tenant.” While a tenant retains control of the property, he or she shares ownership during their lifetime with the remainderman (the estate’s heir).

Quicken Loans’ recent article entitled “What Is A Life Estate And What Property Rights Does It Confer?” explains that while the life tenant lives, they’re in control of the property in all respects, except they can’t sell or encumber the property without the consent of the remaindermen. After the life tenant passes away, the remainderman inherits the property and avoids probate. This is a popular estate planning tool that automatically transfers ownership at the life tenant’s death to their heirs.

The life estate deed shows the terms of the life estate. Upon the death of the life tenant, the heir must only provide the death certificate to the county clerk to assume total ownership of the property.

Medicaid can play an essential role in many older adults’ lives, giving them the financial support needed for nursing facilities, home health care and more. However, the government considers your assets when calculating Medicaid eligibility. As a result, owning a home – or selling it and keeping the proceeds – could impact those benefits. When determining your eligibility for Medicaid, most states will use a five-year look-back period. This means they will total up all the assets you’ve held, sold, or transferred over the last five years. If the value of these assets passes above a certain threshold, you’ll likely be ineligible for Medicaid assistance.

However, a life estate can help elderly property owners avoid selling their home to pay for nursing home expenses. If your life estate deed was established more than five years before you first apply for benefits, the homeownership transfer would not count against you for Medicaid eligibility purposes.

To ensure you’re correctly navigating qualifying for Medicaid, it’s smart to discuss your situation with an attorney specializing in Medicaid issues.

Reference: Quicken Loans (Aug. 9, 2022) “What Is A Life Estate And What Property Rights Does It Confer?”

Can You Remove Someone from a Life Estate?

Can You Remove Someone from a Life Estate?

Parents often use life estates to leave the family home to children, while remaining in the house for the rest of their lives. However, sometimes things don’t work out as intended. If and how changes may be made to a life estate is the focus of a recent article “How to Remove Someone from a Life Estate” from Yahoo! Finance. For the life estate to be flexible, certain provisions must be in the document when it is first created. An experienced estate planning attorney is needed to do this right.

A life estate allows two or more people to jointly own real estate property. One person, referred to as the “life tenant” has ownership of the property for as long as they live. The other person, called the “remainderman,” takes possession only after the life tenant’s death. Multiple people can be named as life tenant and remainderman. However, the more people involved, the more complicated this arrangement becomes.

The remainderman has an unusual position. They don’t have full possession of the property until the life tenant dies, yet they have an interest in the property. The life tenant is not allowed to do certain things, like take out a mortgage or sell the property, without the consent of the remainderman.

The remainderman must agree to any changes in any person or persons named as other remainderman. If there’s more than one, which happens when there’s more than one adult child, for instance, all of the remaindermen must agree, before any names on the life estate can be removed or changed.

If one of the remainderman becomes heavily indebted, has a contentious divorce, or is sued for a considerable sum, their share of the property could be lost to creditors, ex-spouses, or adversaries. In that case, removing the problematic remainderman could protect the value of the home.

Most life estates are irrevocable, and the laws concerning life estates vary by state.

One way to work around the need for remainderman approval, is to use a Testamentary Power of Appointment, a clause in a will permitting the life tenant to change the person to whom the property will be left upon death. Invoking the Power of Appointment doesn’t make the life estate invalid, so the tenant is still constrained from selling the property or taking any other actions without permission from the remaindermen.

The testamentary power of appointment does give the life tenant some negotiating muscle but must be built into the documents from the start.

Another trust used in this situation is the Nominee Realty Trust. This is a revocable trust holding legal title to real estate. A property owner files a new deed transferring ownership to the nominee realty trust. The trust specifies who receives the property after the owner’s death. The grantor of the nominee trust can direct the actions of the trustee, so the life tenant has the legal ability to tell the trustee to change the names of the remaindermen. This flexibility may be desirable when the children are problematic. This has to be set up when the life estate is first established.

There are occasions when the remainderman wants to terminate the interest of the life tenant. This is actually easier than removing or changing the remainderman but requires the life tenant to do something particularly egregious or illegal. The life tenant has certain rights: to rent out the property, to change or improve the property—as long as the property is being improved. The life tenant is responsible for paying taxes, maintaining the property and avoiding any liens being placed on the property.

If the life tenant does not fulfill their responsibilities or allows the property to lose value, it may be possible for the remainderman to have the life tenant’s interest terminated. However, that depends upon the provisions in the life estate. This option should be discussed and planned for when the life estate is created.

Reference: Yahoo! Finance (Dec. 16, 2021) “How to Remove Someone from a Life Estate”

Should Parent Transfer House to Kid?

Should Parent Transfer House to Kid?

Let us say the parent is 90 and has a will bequeathing a home to a child, a son. The house was purchased 20 years ago for $300,000 and is now worth about $400,000.

The child stays there occasionally to help care for the parent, but he doesn’t live there. The parents’ estate is otherwise worth less than $1 million.

Nj.com’s recent article entitled “What are the pros and cons of transferring a home’s title?” explains that there are two primary reasons why parents want to transfer their home to their children.

First, they think they will be able to protect the house, in the event the parent needs to move to a nursing home. Second, they want to avoid probate.

Because many states now have a simple probate process for smaller estates, probate avoidance alone isn’t a worthwhile rationale to transfer the house to a child.

The transfer of the house to a child who doesn’t live there will be subject to the look-back rule for Medicaid, which in most states is now five years. As a result, if a parent transfers the house to the child within five years of applying for Medicaid, the transfer will trigger a penalty which will begin when the Medicaid application is submitted. The length of the penalty period depends on the value of the house. Therefore, if the parent might require nursing home care in the next five years, the parent should have enough other assets to cover the penalty period or wait five years before applying for Medicaid.

In addition, the transfer of the house may also cause a significant capital gains tax liability to the child when the house is sold. That’s because the child will receive the house with the carryover basis of the parent. However, if the child inherits the house, the child will get a step-up in basis—the basis will be the value of the house at the date of the parent’s death.

If the parent transferring the house retains a life estate—the right to live in the house until he or she passes away—the property will get a step-up in basis to the value of the house at the date of death.  In the event that the house is sold while the parent is still alive, the value of the life estate interest will be excluded from income tax but the value of the child’s remainder interest in the house may be subject to capital gain taxes.

Last, if the house is transferred to a child who has financial troubles, the child’s creditors may be able to force the child to sell the house to pay his debts.

Reference: nj.com (April 20, 2021) “What are the pros and cons of transferring a home’s title?”

Is Transferring House to Children a Good Idea?

Is Transferring House to Children a Good Idea?

Transferring your house to your children while you’re alive may avoid probate. However, gifting a home also can mean a rather large and unnecessary tax bill. It also may place your house at risk, if your children get sued or file for bankruptcy.

You also could be making a mistake, if you hope it will help keep the house from being consumed by nursing home bills.

There are better ways to transfer a house to your children, as well as a little-known potential fix that may help even if the giver has since died, says Considerable’s recent article entitled “Should you transfer your house to your adult kids?”

If a parent signs a quitclaim to give her son the house and then dies, it can potentially mean a tax bill of thousands of dollars for the son.

Families who see this error in time can undo the damage, by gifting the house back to the parent.

People will also transfer a home to try to qualify for Medicaid, but any gifts or transfers made within five years of applying for Medicaid can result in a penalty period when seniors are disqualified from receiving benefits.

In addition, transferring your home to another person can expose you to their financial problems because their creditors could file liens on your home and, depending on state law, take some or most of its value. If the child divorces, the house could become an asset that must be divided as part of the marital estate.

Section 2036 of the Internal Revenue Code says that if the parent were to retain a “life interest” in the property, which includes the right to continue living there, the home would remain in her estate rather than be considered a completed gift. However, there are rules for what constitutes a life interest, including the power to determine what happens to the property and liability for its bills.

There are other ways to avoid probate. Many states and DC permit “transfer on death” deeds that let homeowners transfer their homes at death without probate.

Another option is a living trust, which can ensure that all assets avoid probate.

Many states also have simplified probate procedures for smaller estates.

Reference: Considerable (Sep. 18) “Should you transfer your house to your adult kids?”

Should I Give My Kid the House Now or Leave It to Him in My Will?

Should I Give My Kid the House Now or Leave It to Him in My Will?

Transferring your house to your children while you’re alive may avoid probate, the court process that otherwise follows death. However, gifting a home also can result in a big, unnecessary tax burden and put your house at risk, if your children are sued or file for bankruptcy.

Further, you also could be making a big mistake, if you hope it will help keep the house from being used for your nursing home bills.

MarketWatch’s recent article entitled “Why you shouldn’t give your house to your adult children” advises that there are better ways to transfer a house to your children, as well as a little-known potential fix that may help even if the giver has since passed away.

If you bequeath a house to your children so that they get it after your death, they get a “step-up in tax basis.” All the appreciation that occurred while the parent owned the house is never taxed. However, when a parent gives an adult child a house, it can be a tax nightmare for the recipient. For example, if the mother paid $16,000 for her home in 1976, and the current market value is $200,000, none of that gain would be taxable, if the son inherited the house.

Families who see this mistake in time can undo the damage, by gifting the house back to the parent.

Sometimes people transfer a home to try to qualify for Medicaid, the government program that pays health care and nursing home bills for the poor. However, any gifts or transfers made within five years of applying for the program can result in a penalty period, when seniors are disqualified from receiving benefits.

In addition, giving your home to someone else also can expose you to their financial problems. Their creditors could file liens on your home and, depending on state law, get some or most of its value. In a divorce, the house could become an asset that must be sold and divided in a property settlement.

However, Tax Code says that if the parent retains a “life interest” or “life estate” in the property, which includes the right to continue living there, the home would remain in her estate rather than be considered a completed gift.

There are specific rules for what qualifies as a life interest, including the power to determine what happens to the property and liability for its bills. To make certain, a child, as executor of his mother’s estate, could file a gift tax return on her behalf to show that he was given a “remainder interest,” or the right to inherit when his mother’s life interest expired at her death.

There are smarter ways to transfer a house. There are other ways around probate. Many states and DC permit “transfer on death” deeds that let people leave their homes to beneficiaries without having to go through probate. Another option is a living trust.

Reference: MarketWatch (April 16, 2020) “Why you shouldn’t give your house to your adult children”

Do It Yourself Wills Go Wrong–Fast

Do It Yourself Wills Go Wrong–Fast

What happens when a well-meaning person decides to create a will, after reading information from various sources on the internet? There’s no end of problems, as described in the Glen Rose Reporter’s article “Do-it-yourself estate plan goes awry.”

The woman started her plan by deeding her home to her three children, retaining a life estate for herself.

By doing so, she has eliminated the possibility of either selling the house or taking out a reverse mortgage on the home, if she ever needs to tap its equity.

Since she is neither an estate planning attorney nor an accountant, she missed the tax issue completely.

By deeding the house, the transfer has caused a taxable transaction. Therefore, she needs to file a gift tax return because of it. At the same time, her life estate diminishes the value of the gift, and her estate is not large enough to require her to actually pay any tax.

She was puzzled to learn this, since there wasn’t any tax when her husband died and left his share of the house to her. That’s because the transfer of community property between spouses is not a taxable event.

However, that wasn’t the only tax issue to consider. When the house passed to her from her husband, she got a stepped-up basis, meaning that since the house had appreciated in value since she bought it, she only had to pay taxes on the difference in the increased value at the time of her husband’s death and what she sold the property for.

By transferring the house to the children, they don’t get a stepped-up basis. This doesn’t apply to a gift made during one’s lifetime. When the children get ready to sell the home, the basis will be the value that was established at the time of her husband’s death, even if the property increased in value by the time of the mother’s death. The children will have to pay tax on the difference between that value, which is likely to be quite lower, and the sale price of the house.

There are many overlapping issues that go into creating an estate plan. The average person who doesn’t handle estate planning on a regular basis (and even an attorney who does not handle estate planning on a regular basis), doesn’t know how one fact can impact another.

Sitting down with an estate planning attorney, who understands the tax issues surrounding estate planning, gifting, real estate, and inheritances, will protect the value of the assets being passed to the next generation and protect the family. It’s money well spent.

Reference: Glen Rose Reporter (September 17, 2019) “Do-it-yourself estate plan goes awry”