What Is a Life Estate? Understanding Your Options

If you've started thinking about estate planning, you're probably considering how to ensure your home goes to your loved ones after you pass away. Legal options for passing on your property include trusts, wills and life estates. Before you decide which one you need, it's important to understand what a life estate is and how it works. 

What Is a Life Estate?

A life estate is a form of joint ownership that allows you to live in your home during your lifetime. Upon your death, the property passes to the co-owner, known as the beneficiary or remainder owner. This is a way to pre-gift your home to your heirs while still protecting your own shelter.

It's important to note that while you remain living there, you're responsible for property taxes, insurance and other expenses. Your beneficiary also doesn't have any right to visit or live on the property without your permission. However, you won't be able to sell or mortgage the house without the beneficiary's consent. 

What Is the Point of a Life Estate?

The biggest benefit of a life estate is that it simplifies the transfer of property after your death. The property transfers immediately, so your heirs don't need to wait for the probate process, which can be lengthy. 

There are also some financial benefits for your heirs. A life estate can't be used to satisfy your creditors after you die. Furthermore, if they choose to sell, the valuation is taken from the date they got full control of the property, rather than the date you bought it. This can protect them from a large capital gains tax bill. 

A life estate may lower your assets for Medicaid purposes, although in most states, a home isn't counted if you're still living there. However, this may benefit you if you're moving into a nursing home or assisted living facility. The property may also be protected from Medicaid estate recovery, depending on where you live.

You should always check with an attorney or Medicaid planner before doing anything to ensure you understand the Medicaid rules in your state. 

Disadvantages of a Life Estate

As mentioned above, a life estate essentially gives part ownership of the property to someone else. This means that you, as the life tenant, must get approval before refinancing, selling or making any significant changes to the property. The life estate also can't be revoked without the remainder owner's consent.

While this ownership structure protects the property from your creditors after your death, there's no such protection from the beneficiary's creditors. If the remainder owner has debts, a lien can be placed on the house. 

Although there are capital gains tax savings in a life estate, there's no minimization of estate tax. If your property meets the limits for estate tax, your heirs will have to pay it. 

Finally, if the property gets sold, the proceeds aren't shared equally. Essentially, the IRS decides how much each owner receives, and it takes how long you've lived there as a life tenant into account. This means the older the life tenant is, the less they usually get. 

How to Create a Life Estate

Life estates are created by filing a life estate deed. These are short legal documents that include the name and address of everyone involved, the date the deed was made and the signatures of all parties. Free templates are available, but it's best to talk to an attorney before signing. An elder law attorney can help you understand the full ramifications of creating a life estate and ensure the deed you draw up meets your state's regulations. 

Once the deed is completed, it must be filed with the local recording office to make it valid. This is usually your county recorder's office. 

What Happens at the End of a Life Estate?

A life estate ends when one of the people named dies. In most cases, it will be the life tenant who passes away. When this happens, the beneficiary must file the person's death certificate, and then the property transfers to them immediately. 

This negates the need to wait for probate on a will. Once this happens, the beneficiary can sell or rent the property, or they can move in and use it as a principal place of residence. 

If the remainder owner dies first, their ownership interest must be probated. Whoever is named in their will or determined to be their heir will become the new beneficiary.