Life estates are used for a number of estate planning purposes, but the most common way to use a life estate is to help a parent transfer a home to a child, while staying in their home.
There are pros and cons to using a life estate, when a parent wants to transfer ownership of their home to a child. There are certain restrictions to be considered. The parent still also has financial responsibility for the upkeep of the home.
nj.com’s recent article, “How does a life estate work to transfer a home to a child?” explains that as a result of the transfer, the child becomes the owner of the home but the parent has certain rights and responsibilities.
The most critical right retained with a life estate, is the exclusive right to reside in the property. A child cannot force the parent to move out, and likewise, the child doesn’t have any right to live there. The child can live with their parent, but the deed doesn’t give the child the legal right to live there.
With a life estate, the parent must pay the property taxes and all the regular maintenance connected to the property. In addition, the life tenant is responsible for repairs—but not improvements.
This can be hard to determine, but typically the life tenant must maintain the property in the same condition, as when the life estate deed was signed. Therefore, if the parent moves out, and the property is rented, the parent has the right to receive all of the rents.
When the parent passes away, the life estate automatically ceases and the child now has all of the rights associated with the property.
As far as income tax, when the parent dies, the property receives a “step up” in basis to the date of death value. If the property is sold after the parent dies, the capital gain or loss is calculated by deducting the date of death value from the sales price. It’s a very important tax advantage, if the parent has owned the home for a long time and the property has a low basis.
Retaining the life estate can help the child avoid the capital gains tax more effectively than just transferring the property outright to the child.
However, in contrast, if the property is sold while the parent is still alive, part of the proceeds will be allocated to the parent and part will be allocated to the child.
Only the percentage that’s allocated to the parent will be excluded from income under the federal tax laws. The part that’s allocated to the child may be subject to capital gains taxation.
There are other things to consider when deciding whether or not to use a life estate. If an aging parent needs to sell the home for long-term care expenses, it becomes a complex transaction. If one of the children files for bankruptcy or divorce, their ownership of the home can become subject to their creditors or ex-spouses.
Talk with an experienced estate planning attorney to discuss the pros and cons of putting the family home into a life estate. It requires thoughtful planning and the guidance of an estate planning attorney, who can foresee potential problems.
Reference: nj.com (July 12, 2019) “How does a life estate work to transfer a home to a child?”