What is a life estate?
A life estate is a type of ownership interest in real estate and the life estate is given by deed but may also be given in a will or trust. A common scenario applies to a parent who wants to “give the house to the children” for estate planning purposes, but maintains control over the property. The parent transfers the real estate by deed to the children but reserves a life estate for him or herself. In this scenario, the parent becomes the “life tenant,” and the children have what is known as a “remainder interest.”
Why a life estate?
The life estate avoids probate because the real estate goes directly to the children upon the death of the life tenant (usually the parent). With proper planning, the life estate can protect the home from a Medicaid lien upon death, although there are certain time limitations.
A life tenant owes certain duties and obligations to the owner of the remainder interest. The life tenant is required to pay real estate taxes assessed against the property during the life tenancy, protect the property from tax sales, and keep the property free from encumbrances and not to allow the property to go to waste
What are the risks?
There are some risks associated. A life estate is a legal transfer of the remainder interest to the children. Thus according to the IRS, it is a gift and you will need to file a gift tax return for the value of the remainder interest if it exceeds the annual federal gift exemption. Also, if the home is sold during the life of the parent, then the children will receive a share of the proceeds and may have to pay a capital gains tax. Also, if the parent later wishes to have the remainder interest returned or needs to borrow on the property, the full and voluntary cooperation of all of the children will be required.
While the life estate is a simple and often used planning tool, and some protections can be built in against the risks, it is always best to consult with an experienced estate planning lawyer to ensure that the life estate is right for you.