One of the hardest assets to deal with when trying to avoid probate is your home. Quite a few people assume that because they have a will, their estate will avoid probate, and that is simply untrue. Certain assets, like bank accounts, can avoid the probate process. Almost every financial institution allows you to add a joint owner and/or a beneficiary, which automatically allows that specific asset to pass to said joint owner or beneficiary at your death, bypassing the necessity of formal probate of that asset.
But what about your home, or your other real estate?
While you can jointly own your home/property with anyone, there are certain tax implications to outright adding your children (or someone other than a spouse) to your deed as a joint tenant during your lifetime. You certainly don’t want your joint tenant(s) to sell the house after your death and then have to pay more come tax season, while being hit with significant capital gains taxes. That IS possible if you add someone to your deed as a joint tenant with rights of survivorship or as a tenant in common.
Is there a better way?
As with everything in estate planning, there are certain tools that are better at accomplishing certain goals. A life estate deed is one such tool to help deal with passing your home to the next level beneficiary. It avoids the probate process and automatically passes to the beneficiary you name on the deed. Sounds too easy, right?
What is the catch?
First, let’s discuss what exactly a life estate deed is and how it works. There are two parties to a life estate deed: the grantor(s) or the life tenant(s), and the grantee(s) or the remainderman aka the beneficiaries. Being a life tenant means you retain the right to live in your home for the rest of your life. No one can force you to sell your home. Let me repeat that: as a life tenant, you cannot be forced to sell your home! You are still responsible for paying property taxes, maintenance and upkeep of the property, and any other fees, dues, or assessments against said property.
Being a remainderman means you cannot move into the property, or sell said property, without the life tenant’s consent. A remainderman’s interest fully vests only at the death of the life tenant.
Taxes. What about taxes?
During the life of the life tenant, yearly property taxes do not change. It remains the same unless the county raises the tax value of your home. You retain any homestead exemptions you currently get, or any other exemptions that may regularly be available to you.
At the death of the life tenant, the tax treatment will depend on what the beneficiary decides to do with the property. If the plan is to make it his/her primary residence, they will need to file for homestead exemption and have the taxes moved into their name. If the beneficiary plans to sell the property, the tax basis is the fair market value at the time of the life tenant’s death. The only capital gains tax that will be owed would be if the property’s value increased after the date of the life tenant’s death. This is called a step-up in basis. The beneficiary will receive a 1099-S and will need to speak with a CPA about the proper way to file taxes the year following the sale of the property.
What are the pros and cons of creating a life estate deed?
Let’s talk about the cons first. One of the biggest issues that can arise from a life estate deed is the fact that neither the life tenant, nor the remainderman, may sell the property without the other’s consent. What does that mean? If you, as the life tenant, wish to retire to Florida and need to sell your home in order to do so, you’ll have to get your remainderman to agree to sign off on the sale. And that’s a little more complicated than it actually sounds. When you sell a home in a life estate, your remainderman actually owns a percentage of the property. The older you get, the more the remainderman’s interest grows. Theoretically, two checks will be issued at closing: one to you as the life tenant, and one to your remainderman. An elder law attorney or CPA should be able to help you calculate what that percentage will be. It is based on the age of the life tenant and their life expectancy. Another con to consider is what happens if your beneficiary pre-deceases you? You very well could end up co-owning your property with someone you never intended to, and you can’t force them to sign their interest back over to you. Lastly, if you have a falling out with someone you have already given a life estate to, it can be extremely difficult to undo. Again, you cannot force a remainderman to give back their interest.
Now let’s discuss the good things about them. There are several HUGE advantages to creating a life estate deed. First, they are great to use to avoid formal probate for your property, which can save your family thousands of dollars in legal fees and make it much, much easier to deal with after your death. A lesser known, but still huge, advantage is that creating a life estate deed will protect your home or property from a Medicaid spenddown, so long as it has been in the life estate for at least 5 years before a Medicaid application is necessary. This can keep your family farm or family home from having a lien placed on it, or forcing your family to sell it to pay for your long-term care. And last, but certainly not least, we’ve already talked about the tax advantages in creating a life estate versus outright adding someone to your deed.
Is it right for me?
Ask yourself these three basic questions:
- Do you own property?
- Do you know who you want to receive the property at your death, and do you trust them enough to make decisions with you and not against you?
- Will you need Medicaid within the next five years?
A life estate deed may be the perfect tool for you to use to pass your property to a beneficiary of your choosing, but there are many things to take into consideration before doing so. We do these often, and can help you decide whether this, or another tool, is the best option for you.
Jennifer Taylor
Attorney at Law
Nolan Elder Law and Estate Planning, LLC