PROS AND CONS OF LIFE ESTATES
The Life Estate
A life estate is very simple and cheap to create. All that is necessary to create a life estate is for the owner(s) of an asset to transfer title to the asset to another person, but retain the right to use, possess and control the asset during his or her lifetime.
Life estates are most commonly used with real estate and are created by the owner of the real estate by signing and delivering a deed to the property to the person(s) that the owner wants to give it to, but that contains a clause reading substantially as follows:
"Reserving unto the Grantor a Life Estate in the Property conveyed hereby".
If a lawyer is hired to draft the deed and record the deed, the total cost for the document preparation will probably be less than $100.00.
We caution you, however, that if that is all the lawyer does is prepare the deed without discussing in detail the items that follow, you are "buying a pig in a poke"- you do not know what you are getting.
Advantages of a Life Estate
There are good reasons for a person to create a life estate principally: probate avoidance and medical assistance (nursing home) planning.
Upon the death of a person who has retained a life estate in property, the fee title to the property is transferred by the preparation and filing with the real estate recording office a simple affidavit of survivorship. If a lawyer is involved in the preparation and filing of this document, the cost with filing fees will probably be around $100.00. No probate proceeding will be required to transfer title.
The transfer/gift of the property to the persons who are deeded the property is a completed gift/transfer. Detailed regulations exist that specify the value of the asset transferred (known as the remainder interest) and the value of the retained life estate. For example, if a person that is 70 years old that deeds away his/her property that is worth $100,000.00 and retains a life estate he/she is deemed to have given away a remainder interest worth $39,478 and to have retained a life estate worth $60,522. The value of the life estate is important if there is a sale of the property prior to the death of the person holding the life estate. The value of the life estate is also important to determine the amount that can be claimed as a lien against the property if the life tenant received medical assistance.
Disadvantages of Life Estates
The old adage "there is no free lunch" is applicable to the creation of life estates.
The following are some possible adverse side effects for creating a life estate by transferring your property to your children:
If you wish to sell or mortgage your property, all of your children and their spouses, must sign the deed or mortgage.
If any of your children have financial difficulties and have a judgement or tax lien against them, it may well become a lien on "your" property. Thus, your child's financial problems have now become your problem.
If any of your children have marital problems which end in divorce, their remainder interest may figure in your child's property settlement. Again, your child's marital problems then become your problem as well.
In the event of a sale of the property before your death, if there is a taxable gain, your children will have to pay income tax on a portion of the gain. This is a very real and significant problem because you probably would be able to exclude most of the gain under the tax rule that allows an elderly person to exclude $250,000.00 ($500,000.00 for a married couple) of gain on a sale of a home once during his/her lifetime. The amount of gain will be determined based on the value of the life estate and remainder interest on the date of the sale as determined by the regulations (see the example above of a 70 year old person where the value of the life estate is 60.52% and the value of the remainder interest is 39.48% of the total value of the property).
In the event of a sale of the property during your lifetime, your children will receive part of the sale proceeds and they will have no legal obligation to return any portion of it to you. The amount they receive and the amount you keep is again determined by the regulations described above.
If you are receiving nursing home care and the property is sold, it will be necessary to use a portion of the sale proceeds to pay for your nursing home care expense. The percentage is determined by the regulations described above. Likewise, if you receive medical assistance upon your death a lien can be placed against your property that is equal to the value of your interest in the property on the date of your death as determined by the above regulations.
If any of your children die before you, it will be necessary to probate that child's estate. Usually, a remainder interest owned by a deceased child will go to his or her spouse, if they are married. This will require some special effort to have the surviving spouse transfer the property to your grandchildren.
The property will be included in your taxable estate for estate tax purposes.
If, at a later time, you want your children to give back their remainder interest, you will probably find that it will have a harmful effect on your children because the gift back to you will probably be regarded as a future interest and, therefore, increase the amount of their estate taxes they may have to pay. This may have a harmful effect on your children's estate tax situation at the time of their death. Your children will be required to file a Gift Tax Return with respect to any gift back to you.
When you create a life estate, a gift is automatically made to your children. The gift is known as the remainder interest. This gift disqualifies you for medical assistance (help with nursing home bills) for the then applicable "look back" period. Sufficient cash assets must be reserved to pay for nursing home care during that time. You will also have to file a Gift Tax Return with respect to the transfer made by you.
If you become deceased, your children most likely will receive a stepped up basis in the property for income tax purposes; therefore, your children may resist any offers to sell the property during your lifetime.
There can be disagreements between the life tenant and the remainder men with respect to the responsibility for paying for improvements to the real estate. The general rule is that the life tenant is responsible for the maintenance and the remainder men are responsible for improvements. Some items, for example, the replacement of a deck, sometimes get into a grey area and cause disagreements.
The bottom line of all of the above is this: by creating a life estate, you are giving up control of your property and the only persons that will benefit from the transfer is the person you transfer the property to- not you.
We have a number of clients who have declined to create life estates after we have discussed the items set forth above. We have a number of clients who have decided to create life estate after we have had such discussion. We do believe, however, that the decisions in all instances were informed decisions.