What Is a Life Estate?
A life estate is property, usually a residence, that an individual owns and may use for the duration of their lifetime. This person, called the life tenant, shares ownership of the property with another person. This person is called the remainderman, and automatically receives the title to the property upon the life tenant's death.
In the U.S., homeowners most often create life estates to ensure that the next generation eventually gets the family home while avoiding probate, the legal process of proving a will.
- A life estate is a type of legal joint property ownership.
- Under a life estate, the owners have the right to use the property for life.
- Typically, the life estate process is adopted to streamline inheritance while avoiding probate.
- The life tenant retains all the rights and responsibilities of an owner except the right to sell or mortgage the property.
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Understanding a Life Estate
A life estate is a form of joint homeownership. Ownership is shared between a life tenant and a so-called "remainderman." As the name suggests, the remainderman has an ownership interest but cannot take possession until the life tenant's death. The life tenant may live in the home but may not sell it or mortgage it without the agreement of the remainderman.
The life estate is established with a deed that states that the occupant(s) of the property is allowed to use it for the duration of their lives. The deed will also name the person who will receive the property after the life tenant's death.
In France, a homebuyer can arrange a life tenancy with an elderly homeowner and pay that person a regular income in return for being named as the designated remainderman. This is called a viager.
Within a life estate, the life estate deed is a document that grants the owner the ability to pass on ownership of a property without including it in a will as part of a person's assets. As a result, the property does not have to go through probate—the court process used to validate wills. The probate process can be costly and complicated when the estate is very substantial or unusually complex.
If there is a life estate, the life tenant's interest in the property ends at death, and ownership is transferred to the remainderman. The life tenant is the property owner for life and is responsible for costs such as property taxes, insurance, and maintenance. Additionally, the life tenant also retains any tax benefits of homeownership.
Life Insurance As an Income Stream
While a life estate is usually created to streamline the transfer of homeownership to the next generation, it can also be used to establish an income stream.
Life estates can be created to provide a life-long income for a person rather than a lump-sum inheritance. In this case, the estate consists of money invested in income-producing instruments, such as bonds, oil and gas leases, real estate investment trusts (REITs), and other similar investments. Under this arrangement, the life tenant receives income for life, but they cannot access the principal amount.
No matter what type of property is involved in a life estate, the life tenant cannot sell it or borrow money against it without the agreement of the remainderman. If both agree to the sale, the remainderman could demand a portion of the proceeds based on a predetermined scale that reflects the life tenant’s age and current interest rates. Typically, the older the life tenant, the greater the share the remainderman can expect to receive.
How to Create a Life Estate
Once you've considered creating a life estate and have decided it's what you need, there are only a few steps:
- Consult an attorney: An attorney can help you finalize your decision and become more familiar with the estate laws in your area.
- Draft your life estate deed: It is possible to draft the deed yourself, but you're better off hiring an attorney to do it for you so there are no errors, mistakes, or omissions.
- Record your life estate deed: Take your deed to the county clerk or recorder's office. It needs to be filed with the county to be valid.
Alternatives to a Life Estate
A life estate is an excellent tool for securing your assets to pass to your beneficiaries and bypass lengthy probate, but it isn't the only option available. You can also create a:
- Transfer-on-death-deed: This deed passes on real estate to your heirs after your death. You can change this deed anytime, making it a flexible alternative to a life estate.
- Revocable living trust: You place the assets in this trust to protect them from creditors and probate. It can also be revoked or changed and is another flexible alternative to a life estate.
- Irrevocable living trust: As the name implies, you place your estate in this trust and cannot revoke it. Once the assets are in it, you no longer "own" them and cannot change the terms of the trust unless a court rules in your favor.
Life Estate and Medicaid
Medicaid is a state program that ensures people who need to move into a long-term care facility can receive the care. To qualify for Medicaid, you cannot own more than your state allows unless under specific conditions. Medicaid also seeks reimbursement after you die from any estate you may have left.
Medicaid commonly targets a recipient's house because it is generally their most valuable asset. For example, it might place a lien on the house or try to force a sale to recoup the cost of your long-term care.
Under a life estate, the home is no longer an asset of the individual's estate. That shields it from lawsuits, including Medicaid estate recovery.
Types of Life Estates
There are two types of life estates—traditional and enhanced. The enhanced version is typically called a "Lady Bird" deed, commonly thought to have originated when President Johnson transferred property to his wife, Lady Bird Johnson, when he died. However, the practice is much older than that.
The enhanced version differs from the traditional only in that the life tenant can sell the property or take out a mortgage against it without the remainderman's consent, and that it can be revoked.
Advantages and Disadvantages of Life Estates
Life estates carry both advantages and disadvantages. The most notable advantage of the life estate is that it simplifies the transfer of a home to the next generation. If the home is included in the homeowner's will, the probate process may delay the transfer. If there is a life estate, the transfer is automatic when a death certificate is filed.
One other potential advantage: the home is no longer an asset of the estate. If a person is enrolled in Medicaid and receives services paid by it, state governments may sue the estate to recover the costs. A life estate protects it from "Medicaid estate recovery."
In addition to legal benefits, there are potential tax benefits:
- The life tenant may be eligible for some homestead or senior tax breaks as a homeowner.
- The remainderman may receive a substantial capital gains tax break when and if the house is sold (since its tax valuation will be based on its value at the time of the life tenant's death, not at the time it was purchased by the life tenant).
However, there is a potential legal disadvantage as well: the life tenant may become involved in any legal problems that a remainderman incurs. For example, if a parent and a child have created a life estate and the child is sued for nonpayment of taxes, a lien could be filed against the parent’s home.
In any case, creating a life estate is a serious and binding decision for a homeowner. They are giving up the option of selling or mortgaging the home (unless the remainderman agrees) and making an irrevocable choice of an heir to the house.
Simplifies the transfer of a home to the next generation
Protects the home from debtors of the deceased
Allows older homeowners to retain the benefits of home ownership
Makes the owner vulnerable to debt actions brought against the remainderman
Can't be undone easily if the owner's plans or circumstances change
Restricts owner's ability to mortgage or sell property
Life Estate vs. Irrevocable Trust
Like a life estate, an irrevocable trust is often a tool for estate planning. As in a life estate, the irrevocable trust removes assets from the grantor's estate. Specifically, the grantor relinquishes all rights to some assets and income, transferring them to a trust. The assets may be cash, investments, or life insurance policies. The trust's beneficiary may be a spouse, the grantor's children, or a charitable organization.
A life estate is also "irrevocable." Once a life estate deed is filed, the life tenant cannot alter the agreement without the consent of the remainderman.
An irrevocable trust does have its uses, however. A trust can reduce a person's wealth on paper while transferring that wealth to family members. It also removes some of the person's assets from an estate, eliminating them from the probate process.
A trust can be a valuable strategy for a professional vulnerable to lawsuits—such as a physician—because it protects some of their assets by transferring them to family members under a trust.
Unlike a life estate, a trust may not provide a benefit, such as a residence, to the grantor.
Example of a Life Estate
A life estate agreement is usually undertaken as an aspect of estate planning. For example, an older couple might consider a life estate arrangement as an alternative to naming a beneficiary in their wills. A life estate agreement gives them the right to stay in their home for the rest of their lives. Then, when they are both deceased, an adult child or children will automatically take title to the property.
A widowed homeowner who can no longer live alone might create a life estate agreement with an adult child as the remainderman. The parent and child now co-own the home, but the parent retains lifetime rights to use the home. Both assure that home ownership will pass to the child without delay or interruption.
What Is a Life Estate for Dummies?
A life estate is a legal document that splits ownership of property, so that the first party retains rights to use the property and the second party retains rights to inherit it.
What Are the Disadvantages of a Life Estate?
If you have a life estate on a property, you cannot refinance, sell, or alter it without the remainderman's (the second party) permission.
Who Pays the Inheritance Tax When the Life Tenant Dies?
If an estate is subject to an inheritance tax, the life tenant's estate is responsible for paying the tax.
Who Owns the Property in a Life Estate?
The property is owned by all designated parties in a life estate deed. However, the life tenant retains the right to occupy the estate.
The Bottom Line
Creating a life estate is a reasonable way for homeowners to ensure that their home will be passed on to the person they want it to be, with minimal legal fuss or delay. However, a life estate should only be established with the full understanding that it can't be undone easily. The homeowner is giving up the right to sell the property or get a mortgage on it without the cooperation of the remainderman.