For seniors in New York that are in the midst of updating their estate plan or even undertaking one for the first time, the use of a life estate may be an excellent planning tool to discuss with your attorney. For the uninitiated, the term “life estate" is likely somewhat of a foreign term that you’ve never considered. Contrary to any potential first impressions that it may cast, when used properly, life estates can be a wonderful tool to not only preserve one of your likely most valuable assets, your home, but also simplify its transfers when you pass away.
At its most basic level, granting someone a life estate amounts to no more than deeding your property over to your intended heirs on a pre-death basis. Doesn’t sound too complicated, right, but you might be asking yourself what about all the tax consequences that are likely to accompany such a transfer? And more importantly, where am I going to live once I transfer my home away?
By way of estate planning tools, life estates have several advantages that will be enjoyed once undertaken, but the most critical advantage is suggested by the name life estate itself. When one grants a life estate, they reserve for themselves the right to retain, use, occupy and pretty much all other property rights (and obligations) that come with home ownership. The property remains yours until you actually pass away.
When you pass away, a couple of important things occur. First, the property automatically transfers outright to the heirs you named on the deed without the need for probate. Given that homes are often a person or couple’s most significant asset, having it pass outside of probate has the potential to significantly reduce an estate’s legal and administrative fees.
The second major advantage that your heirs will enjoy once you pass is that they will receive the property on a “stepped-up basis". This means that the value assigned to your home when you pass will be fair market value rather than the price you paid for it. Where the home has appreciated significantly, the import of this fact is tremendous because it will allow your heirs to sell the house within six months of your passing and no capital gains taxes will be due on the increased value. After that initial six month period, any increase in value over and above the fair market value assigned at the time of death will be subject to capital gains tax at the normal rate.
There are some instances where one will transfer property to his or her intended heirs without the reservation of a life estate. In terms of maximizing the interests of the parties involved and minimizing the potential tax liabilities that might have to be paid, this can be a problematic strategy. While there is some precedent for the Internal Revenue Service to deem such a transfer as a life estate so long as certain criteria are met, including that the parent has remained in the premises without paying rent for the balance of his or her life, I wouldn’t necessarily bank on the IRS granting that status in every instance. If you’re considering transferring real estate to your heirs, it’s best to take chance out of the equation and do it properly through a life estate.
A final issue I would raise concerning life estates relates to their potential impact on Medicaid eligibility. Medicaid rules changed in 2011, and they quite honestly appear to be ever changing. That said, it looks like Medicaid has not only instituted a look back period for qualification when a life estate is retained (although it’s calculated somewhat differently than when a life estate is not retained), but there can also be a lien attached to your estate for the value of the life estate. Given these realities, if you are someone likely to be or become Medicaid dependent, it’s best to consult with a qualified elder law attorney before transferring any home or applying for Medicaid.
When it comes to planning for your future, or more particularly, the disposition of your assets, most people prefer to make the process as simple and seamless as possible, and a life estate will allow that (at least to a degree). Are they right for everyone? Certainly not, but if you and your family could benefit from such a planning strategy, it’s at least worth your consideration. Before undertaking any such strategy though, it is critical to consult with not only your attorney, but also an accountant who can advise you relative to any potential tax consequences that might be incurred, including capital gains taxes, estate taxes or gift taxes.