Life Estates, Part 2: Why You May Want One

In my first blog “Life Estates in North Carolina,” I noted that a life estate is the interest in property that is measured by the life of a person.  It can be granted to someone for his or her lifetime or for the lifetime of another.  The life estate interest gives the holder the right to all the benefits of the property during the lifetime for which it is granted.  Upon the death of the measuring life, the property automatically vests in a remainderman or the future interest holder.

Reasons why a person may want to establish a life estate vary. One reason may be so that the property does not go through probate at the death of the life interest holder. When a person holds title to property in their name at their death, even if a will exists, the property may need to go through a probate process before heirs can sell or mortgage the property.

Other reasons to establish a life estate may be for estate and long term care planning purposes. Without getting into the details of the tax code and Medicare rules, which is an exercise better left to the tax and estate planning professionals of our firm, it is true that life estates are often tools people choose to use in their estate and long term care plans. One reason this type of transfer is considered may be because a life estate in the property allows a transfer of the property while maintaining what is known as a step-up in basis of the real estate. This occurs because the property will remain an asset of the life interest holder’s estate until their death. Heirs who inherit the property inherit it at its value at the date of death of the life interest holder, not when the life estate was established. In theory this would likely mean that capital gains may be avoided when the heir goes to sale the property. This is more likely when the sale is relatively soon after the life interest holder’s death and the property has not appreciated in value since their death.

Life estate transfers are also used for long term care planning purposes as it allows an aging person to remain in their home and, when handled properly, not be subject the transfer to a Medicaid transfer penalty. The question often arises, “will the transfer of the home to the children, trust or another person while retaining a life interest disqualify me from receiving Medicaid.” The answer as you may imagine is not as straight forward as the question. Advice from those who are knowledgeable in this area is important because while it may be true that a life estate may not be considered a countable asset for Medicaid purpose, a transfer of something of value, and often the property is something of value, will raise issues as to whether a transfer penalty will apply if the transfer is within the last five years. Caution and careful planning is key. These rules can and do change and there are strategies that can be employed to ensure adequate protection of ownership interests.