From time to time, homeowners decide they would like to simplify their estate planning process and utilize a common estate planning vehicle known as a life estate deed which utilizes a deed to direct for the distribution of their property. There are two types of life estate deeds that can be utilized: (i) a Life Estate With Powers; and (ii) a Life Estate Without Powers. Each has its own advantages and disadvantages.
Life Estate With Powers
A Life Estate With Powers is very similar to beneficiary designations commonly found on life insurance policies and retirement accounts. In order to create a Life Estate With Powers, the homeowner executes a deed to their designated beneficiary(ies), known as a Remainderman, but reserves a “life estate interest” in the property, as well as a number of powers related to the property to which they still retain for the duration of their life. Those powers related to the property can include items such as the ability to sell, mortgage, lease, or dispose of the property prior to their death. The full interest does not vest in the Remainderman until the death of the Life Tenant. That transfer occurs automatically by operation of law and is not subject to the estate probate process. While that concept sounds appealing to many, it does have some drawbacks. Most properties that are in life estates are not eligible for conventional mortgage financing. For those who are considering Medicaid planning, the property is still considered a countable resource since this type of life estate is not a completed transfer until the date of death of the Life Tenant. Lastly, if the Remainderman were to predecease the Life Tenant, the remainder interest would become an estate asset of the Remainderman.
Life Estate Without Powers
A Life Estate Without Powers on the other hand has a very similar structure to that of one with powers, with the exception that when it is created, there is no reservation of powers for the Life Tenant. This can be thought of as an irrevocable beneficiary designation. Thus, it creates a completed gift transfer to the Remainderman. The Life Tenant no longer has the ability to dictate what is done with the property and cannot unilaterally change its ultimate distribution without the consent and joinder of the Remainderman. That would require the Remainderman to execute a deed in connection with the Life Tenant to modify the terms of the life estate. This also subjects the property to creditors of the Remainderman. In contrast to a life estate with powers, this method can protect the property from creditors of the life tenant. The transfer itself (as it’s a completed gift) starts the tolling clock for the five-year Medicaid lookback time period and thus is a heavily used tool when consumers are worried about Medicaid planning and asset protection.
Tax Implications
There can be unintended consequences for both types of instruments. Other than opening up the property to additional creditor claims of the Remainderman, the most notable unintended consequence is it can create a capital gains tax issue for the Remainderman who did not receive a step-up basis at the time of death of the life tenant. Imagine how upset everyone can get when they think that they have avoided the probate process just to find out that they have created a massive tax liability on the person receiving the property. It is incredibly important to speak with an accountant to discuss the potential implications around such a transfer prior to re-titling of the property.
Dealing with Life Estates
If you find yourself in a transaction where there will be a life estate involved, it is important that you quickly identify which type of life estate the property is titled in. When you are preparing the listing or contract documents, you will want to ensure you have the necessary parties execute them accordingly. In the case of a Life Estate With Powers, you may not need the Remainderman to execute any documents, only the Life Tenant. However, a Life Estate Without Powers will need execution from both the Life Tenant and the Remainderman to properly transfer the property to a subsequent owner. If you are not sure, please feel free to contact our office to assist with any questions you may have.
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This article was originally published in Chesapeake Real Producers, February 2021 by Chesapeake Real Producers.