What is a "Life Estate"?
A "life estate" is an estate whose duration is limited to the life of an individual (usually the party holding the life estate), and a legal arrangement whereby the "life tenant" during his or her life retains use (the rights to rents and profits), possession of the property and costs of maintaining the property. The life tenant cannot sell or waste the property without the consent of the "remaindermen".
How is a Life Estate Created?
A legal life estate in real property can be created by conveying the property by a deed which carves out the life estate for the grantor and creates a "remainder interest" by which the "remaindermen" receive full ownership (fee simple) immediately upon the death of the life tenant (grantor).
What Are some Benefits of a Life Estate in a Personal Residence?
- The life tenant has the legal right to remain in her house for as long as she lives. Whereas, if she transferred her house outright, the new owner could legally sell the property the next day forcing the previous owner to vacate the premises.
- The property immediately passes to the remaindermen without the necessity of a probate proceeding.
- A life estate is useful for purposes of Medicaid eligibility and protection from Medicaid recovery by the state as shown by the following example (Medicaid regulations vary from state to state; this example applies to New York Law).
Jane Doe, a 69-year-old widow, owns a home in Westchester County, New York with a fair market value of $250,000.00. Her home is her most valuable asset which she wants to leave to her son. Jane has a progressive illness which renders her ineligible for long term care insurance. Therefore, she may have to apply for Medicaid as her health declines. By drafting a deed which retains a life estate for Jane with the remainder to her son, the following can be accomplished:
- For Medicaid eligibility purposes, the transfer to Jane's son is not the property's fair market value of $250,000.00. Instead the value of the transfer of the remainder to the son according to tables used by the Department of Social Services is .37914 of the fair market value of $250,000.00 or $94,785.00. If Jane had simply transferred the house to her son she would not be eligible to receive Medicaid until 36 months from the date the deed is executed. By retaining a life estate, Jane will be eligible to receive Medicaid after only 14 months have passed form the date of the execution of the deed. (In Connecticut a similar result is achieved using a slightly different methodology.)
- The New York State Department of Social Services recognizes that a life estate is a "limited interest in real property". Therefore, the state will not require Jane to sell the property, nor will the state place a lien on the property as a condition of paying a nursing home Medicaid for Jane's care.
- Both New York and Connecticut Medicaid laws and regulations limit recovery to probate assets of the Medicaid recipient or her spouse (in our example Jane is a widow). Since the life estate is extinguished upon Jane's death, the property passes to her son out of probate and is therefore not recoverable by the state.
- The life tenant remains the owner purposes of real property tax administration, and therefore continues to qualify for the STAR exemption, veteran's benefits, and any other property tax reduction available to the "owner" of the property.
What are the Tax Ramifications of Creating a Life Estate?
Pursuant IRC Section 2702 the gift tax value is the full value of the property, without any discount. Therefore, in the above example for gift tax purposes Jane transferred her home valued at $250,000.00 while retaining a life estate. If the deed is executed in 2017, by April 15, 2018 she must file a federal gift tax return reporting that in the transaction, she utilized $250,000.00 of her $5,490,000 federal gift tax credit. Jane is single, but if she had a spouse together their lifetime federal gift tax credit for 2017 is $11,000,000. Jane would not have to pay any federal or state gift taxes as long as she had not made other large gifts which previously used her federal and state tax credits. (As of January 1, 2000, there is no New York State gift tax).
If Jane lived in Connecticut, she would not owe any state gift tax based upon a gift valued at $250,000.00. Connecticut changed their lifetime gift tax exclusion to $2,000,000. As long as Jane did not exceed this amount in her life time gifts she would owe not gift tax. She would still have to file a Connecticut gift tax form though.
Are Life Estates for Everyone?
No. While a life estate can be advantageous in a Medicaid context, individuals of larger estates with significant estate tax exposure should consider other options, such as the Qualified Personal Residence Trust. The life estate is only one of many estate planning and asset preservation tools. It is important to consult with an attorney in your state regarding Medicaid, real estate, tax, and estate administration laws applicable to your personal circumstances.