What Is a Life Estate, and How Does It Work?

If you own a home, passing that property on to someone else — whether it’s a spouse, your children or someone else — requires planning. That’s where a life estate can come in. A life estate is a legal way to own property with someone else and pass it on to them automatically when you die. Creating this type of ownership arrangement can help remove the property from the probate process. A life estate can also be useful when planning for long-term care needs if you anticipate having to apply for Medicaid.

If you want hands-on guidance navigating this process, consider finding a financial advisor to work with.

What Is a Life Estate?

A life estate is a special ownership arrangement that allows you to share a property with someone else. Each of the people in a life estate has an ownership interest in a piece of real estate — typically your primary home — but over different periods. The person who holds the life estate is called the life tenant. So that’s you if you’re the homeowner since, as the life tenant, you own the property during your lifetime.

The other person in the life estate is called the remainderman. This person has an ownership interest in the home but they can’t technically own it until you pass away. However, when you die, the home becomes theirs automatically.

How a Life Estate Works

A life estate offers a legal way to jointly own property and make ownership transitions smoother after your death. So say you own a home that you want to leave to one of your children. You could establish a life estate deed specifying yourself as the life tenant and your child as the remainderman.

During your lifetime, you can continue to live in the home. You’d be responsible for paying any preexisting mortgage obligations, property taxes and/or homeowner’s insurance for the property. You’d also be responsible for keeping up with maintenance and repairs. As the life tenant, you could also make improvements to the property or even rent it out.

You wouldn’t, however, be able to do certain things such as taking out any kind of mortgage loan against the property, including a home equity conversion mortgage (HECM), without the remainderman’s consent. A life estate deed would also prevent you from selling the home since the remainderman has an ownership interest in it.

At your death, the property would automatically transfer to the remainderman. At that point, they’d be able to do whatever they like with it, including living in it, renting it out or selling it.

Benefits of Creating a Life Estate

Creating a life estate can be a strategic move for individuals looking to manage their property and estate planning effectively. This legal arrangement allows a person to retain the right to use and benefit from a property during their lifetime, while ensuring a smooth transition of ownership upon their passing. Here are some key benefits of establishing a life estate:

Avoidance of probate: A life estate can help bypass the probate process, which can be lengthy and costly. By transferring property ownership directly to beneficiaries upon the life tenant’s death, families can save time and reduce legal expenses.

Retained control and use: The life tenant maintains the right to live in and use the property for the duration of their life. This ensures that individuals can continue to enjoy their home without disruption, while still planning for its future transfer.

Potential tax benefits: Life estates may offer certain tax advantages, such as a step-up in basis for the remainder beneficiaries. This can result in reduced capital gains taxes if the property is sold after the life tenant’s passing.

Protection from creditors: Once a life estate is established, the property is generally protected from the life tenant’s creditors. This can provide peace of mind, knowing that the property is safeguarded for future generations.

Clarity and certainty for heirs: Establishing a life estate provides clear instructions for property transfer, reducing potential disputes among heirs. This clarity can help maintain family harmony and ensure that the property is distributed according to the life tenant’s wishes.

Creating a life estate can offer numerous advantages for those looking to manage their estate planning effectively. By understanding these benefits, individuals can make informed decisions that align with their long-term goals and provide security for their loved ones.

Potential Drawbacks of a Life Estate

Creating a life estate can be an effective estate planning tool, allowing individuals to transfer property while retaining certain rights. However, it’s important to understand the potential drawbacks before proceeding. Here are some key considerations to consider when evaluating the implications of establishing a life estate.

Limited control over property: Once a life estate is established, the original owner, or life tenant, retains the right to use the property during their lifetime but cannot sell or mortgage it without the consent of the remaindermen. This limitation can be restrictive if the life tenant’s financial situation changes or if they wish to relocate.

Potential for family disputes: Life estates can sometimes lead to conflicts among family members, particularly if the remaindermen disagree with the life tenant’s decisions regarding property maintenance or use. These disputes can strain family relationships and may require legal intervention to resolve.

Impact on Medicaid eligibility: Establishing a life estate can affect Medicaid eligibility, as the property may still be considered an asset of the life tenant. This can complicate the process of qualifying for Medicaid benefits, potentially delaying or reducing the assistance available for long-term care.

Tax implications: Life estates can have complex tax consequences, including potential capital gains taxes for the remaindermen when the property is eventually sold. Understanding these tax implications is crucial to avoid unexpected financial burdens.

While a life estate can offer certain benefits, such as avoiding probate, it’s essential to weigh these against the potential drawbacks. Consulting with a legal or financial advisor can provide valuable insights and help determine if a life estate aligns with your overall estate planning goals.

Bottom Line

A life estate can be a useful planning tool for avoiding probate and managing Medicaid eligibility. It’s an option to consider alongside alternatives, such as a revocable trust or passing on ownership through a last will and testament. Talking to an estate planning expert or financial advisor can help you decide if a life estate is a good fit for your needs.

Tips for Investing

Consider talking to a financial advisor about estate planning, Medicaid planning and where a life estate may fit into the picture. If you don’t have a financial advisor yet, finding one doesn’t have to be difficult. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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