A Life Estate Explained

Most people are familiar with the term life estate, but may not understand the exact details of how a life estate operates.  First, “life estate” refers to a real property arrangement.  A life estate is essentially just a method of splitting ownership of real property between two classes of people.  In every valid life estate, there is at least one “life tenant” and at least one “remainderman.”

The life tenants and the remaindermen hold different property interests.  The life tenants are the owners of the property during life.  Each life tenant has the right to live in the property (rent-free) until his or her death.  Following the death of the last life tenant, the property automatically transfers to the remaindermen.  Following the transfer, the remaindermen become the full owners of the property, not subject to any life estate.  One of the fundamental benefits of using a life estate to transfer property is that the transfer happens outside the probate process.  A non-probate transfer allows the remaindermen to become full owners of the property without the cost, delay, and inconvenience associated with the probate process.

Life estates can be created by a will at the property owner’s death. Life estates can also be created by recording a deed during the lifetime of the original property owner.  During life, the life tenant has the responsibility to maintain the property, pay property taxes, and pay any homeowner’s association dues.  The life tenant is also under a duty not to “waste” the property, meaning the life tenant cannot intentionally damage or demolish the property.  For income-producing property, the life tenant also has the right to any income from the property during the life tenant’s life.

One should also note that by creating a life estate, the property owner is transferring a property interest, and this can create tax concerns for both the property owner and the remaindermen.  For example, a life estate can be “retained” for federal estate tax purposes, this means that the person creating the life estate can include the property in her gross estate.

The inclusion of the real property subject to the life estate in a decedent’s gross estate for federal estate tax purposes does provide a benefit.  Specifically, at the death of the last life tenant, the remaindermen will receive a tax-free “step up” in basis.  “Basis” is essentially the last purchase price of an asset.  If the life tenant/original property owner purchased the property a long time ago, the property may have appreciated significantly in value.  Thus, for the remaindermen to have a “step up” in basis of the property, can represent significant savings for capital gains tax purposes.  One should keep in mind that the “step up” in basis occurs at the death of the life tenant, not the subsequent sale of the property.  Additionally, the “stepped up” value becomes the fair market value of the property (at the death of the last life tenant).

If you or anyone you know is interested in obtaining information about life estates, or estate planning advice, the experienced attorneys at Chepenik Trushin LLP are ready, willing, and able to provide advice and assistance. Please do not hesitate to contact us for an initial consultation.