Life Estates 101

Oct 25, 2023 | Uncategorized

Occasionally the idea of a life estate comes up in farm succession discussions. But what should you know about it?

A life estate is a legal mechanism for transferring assets, usually a home or land, intended to remain within the family. Typically, parents pass these assets to their child or children while still retaining the rights to inhabit the property and/or earn from it, like through land rent. Upon their passing, the ownership automatically shifts to the children.

What is a Life Estate?

  • Legal transfer of assets, typically house and/or land, to keep within the family.
  • Allows the original owners (usually parents) to live in the home or receive income rights (like land rent) until they pass away, then the asset transfers to the next set of owners (usually children).

Owners in a Life Estate:

  • Current Owner (Grantor): Person initiating the deed.
  • New Owner (Life Tenant): Owner(s) of the life estate.
  • Future Owner (Remainderman): Individual(s) who inherit the property post-life tenant’s death.
  • One party can have multiple roles, e.g., the grantor often is the life tenant. Multiple people can share a role.

Types of Life Estates:

  • Granted Life Estate: Typically within a will. Upon the passing of one spouse, the other becomes the life tenant with children as remainderman. Helps to avoid probate.
  • Retained Life Estate: Created when the grantor is alive. Property transfers to the remainderman upon grantor’s death. Used as an alternative to a revocable trust and to avoid probate.

 Creation & Asset Inclusion:

  • Created by an attorney through a written document.
  • Executed via a new deed with the county or through a will/trust.
  • Appraisals often advised to determine fair market value for gift tax purposes.
  • Common assets: family real estate, certificates of deposit, bonds, REITS.
  • Depreciable assets are typically avoided.

 Advantages:

  • More cost-effective and efficient compared to other options.
  • Bypasses probate but is part of the taxable estate.
  • Life tenant retains control and usage rights.
  • Sale needs agreement from both life tenant and remainderman.
  • Remainderman gets a stepped-up basis upon life tenant’s death.
  • Some protections from Medicaid costs based on the state.

 Disadvantages:

  • Irrevocability: challenging to alter.
  • Sales prior to life tenant’s death need agreement from both parties; can result in significant capital gains.
  • Assets aren’t safe from lawsuits, divorce, or bankruptcy.
  • Medicaid can mandate asset sales if life tenant moves to an extended care facility within five years of deed creation.
  • Probate may be necessary if the remainderman predeceases the life tenant.
  • Filing a gift tax return may diminish the lifetime exemption.

Conclusion:

In conclusion, while life estates offer unique benefits and long-lasting advantages, they might not suit everyone’s needs. It’s crucial to evaluate individual circumstances and understand the specific requirements associated with this legal mechanism. Although the learning curve and associated costs are relatively low, the potential rewards and peace of mind they can provide are substantial.

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