The hallmark of a life estate is the duration of ownership rights for each who owns the property in a life estate, as well as what those rights are.
A life estate is a form of property ownership that exists to transfer property from one person to another, without burdening that person with the property taxes associated with the real estate. It can also exist in other forms, wherein it involves the transfer of property between three persons – the grantor, the life tenant, and the remainderman.
However, just as there are a slew of benefits to a life estate, there are also a few drawbacks. Understanding who owns the property in a life estate and exactly how ownership works is critical before considering it as part of your estate plan.
Who Owns the Property in a Life Estate? How Does Ownership Work?
Within a life estate, a piece of property is split between possession and ownership. A simple example would be a father transferring ownership over his house to his daughter. In effect, the daughter is now a joint owner of the property, but the father remains in possession of it.
The daughter cannot force her father to vacate and cannot be in possession of the property unless the father permits it. Ownership and possession are both fully transferred to the daughter (the remainderman) upon the father’s death (now called a life tenant).
While alive, the life tenant is the one who owns the property in a life estate and remains in possession of the property with limited ownership rights. And as such, cannot sell the property while retaining maintenance-related responsibilities, including:
- A fiduciary duty to the remainderman to maintain the property’s value.
- The responsibility to cover all expenses and property taxes.
Life estates can also exist wherein the original owner names someone else as the life tenant, and a third person as the remainderman. The original owner (grantor) may also name themselves remainderman. In this case, the property would be given to someone as a life tenant, and then revert to the original owner after the life tenant’s death.
If at any point the remainderman dies, their next of kin automatically inherit the right to take full ownership and possession of the property should the life tenant pass away. Life estates can also be contingent on certain actions detailed within the document of the life estate and may be voided if a life tenant does not abide by these conditions.
Life estates completely override other forms of estate planning in a life tenant’s case,. Meaning, if the father named his daughter as the remainderman but then notes in his will that the house should go to his spouse, it will automatically go to his daughter because a life estate skips probate, and thereby, isn’t considered part of the life tenant’s estate.
While a life tenant cannot sell the property, a remainderman can sell their share. This means they can only sell their ownership rights, which within the terms of the life estate defines that the new buyer would only get full possession after the life tenant’s death and takes over the role of remainderman.
On the other hand, the property may be sold if both the life tenant and the remainderman decide to sell it. The split is not exactly 50/50 – when selling property together, the life tenant gets a share based on their age and life expectancy, getting more the younger they are, and getting less the older they are.
Life estates bypass probate and are not considered a part of the life tenant’s estate, as the property automatically passes to the remainderman. They also do not count as a gift, so there is no gift tax on transferring property through a life estate.
Why You Might Consider a Life Estate
Life estates are worth considering and can serve useful as a:
- Means of transferring property between generations without having it go through the probate process, which can greatly inflate the value of one’s estate and risk estate taxes.
- Cheaper substitute to a trust, although it diminishes the control an individual may have over their property versus, say, a revocable living trust.
- Property gifting or selling alternative, which would burden the buyer (friend or family) with property taxes they may not be able to cover yet, especially if they are a younger adult. There are also other issues with gifting or selling property to a loved one, especially below market value.
However, while an effective way to transfer property, the loss of certain ownership privileges under a life estate may not be attractive to some parents and individuals looking for a way to transfer property to a friend or loved one at minimal costs to everyone involved.
Alternatives to Life Estates
Life estates are not always the right choice. Giving away future ownership to someone else can be tricky, and you cannot ensure that they will not give it away to yet someone else. Not to mention, the fact that, if they pass away, you have no choice but to watch your property go to their next of kin.
Many who do not want to lose that sort of control over property that is near and dear to them while they are still alive choose other options for avoiding that their property goes through probate. The most popular alternative is a trust.
This involves funding the property into a separate entity that holds it “in trust”, usually under a name like “John Doe’s Trust”. As grantor, you remain in control of the trust until you die, at which point a trustee of your choosing is responsible for executing the terms of the trust.
A totten trust (transfer-on-death designation) is another method available in some cases, wherein a property is given to a beneficiary who will automatically receive full ownership upon your death.
The difference is that this beneficiary has nothing to do with the property until you die, at which point it bypasses state and federal estate taxes and the probate process and passes automatically to them. This designation can also be used for certain accounts, assets, and other property.
Finally, you can choose to let the property pass through probate and transfer it in a will. In cases where the total value of an estate is below a certain sum (when including the property), the probate process may be expedited. This sum is often well below the exemption limit for estate taxes and can be a good option when the overall size of the estate is nothing to worry about.
Regardless of what option you choose, it is always best to discuss it with a local estate planning professional first. The difference between saving a fortune and losing one can be quite slim in many cases.