A life estate is a form of property ownership in which a person — called the life tenant — has the right to use and occupy a property for the duration of their lifetime. When the life tenant dies ownership of the property passes automatically to another person or persons — called the remaindermen — without going through probate. Life estates are commonly used as an estate planning tool to transfer property to heirs while allowing the original owner to continue living in the home for the rest of their life.
How a life estate works
When a life estate is created the property owner transfers ownership of the property to one or more remaindermen while retaining a life estate interest for themselves. This is typically done by recording a new deed — called a life estate deed — that names both the life tenant and the remaindermen.
The life tenant retains the right to use and occupy the property for the rest of their life. They can continue to live in the home, rent it out, and generally use it as they see fit subject to certain limitations. When the life tenant dies their interest in the property automatically ends and full ownership passes to the remaindermen without going through probate.
Benefits of a life estate
Life estates offer several potential benefits as an estate planning tool:
- Probate avoidance — because ownership passes automatically to the remaindermen at the life tenant’s death the property does not need to go through probate. This can save time, expense, and the public exposure of probate proceedings.
- Simplicity — a life estate deed is a relatively simple and inexpensive document compared to setting up a living trust
- Medicaid planning — in some states transferring a home into a life estate more than five years before applying for Medicaid can protect the home from Medicaid estate recovery while allowing the life tenant to continue living there. However this is a complex area and the rules vary by state.
- Step-up in basis — when the remaindermen inherit the property they typically receive a stepped-up tax basis equal to the fair market value of the property at the life tenant’s death. This can significantly reduce capital gains taxes if they later sell the property.
- Retained use — the life tenant can continue to live in the home for the rest of their life regardless of what happens to the remaindermen
Limitations of a life estate
Life estates also have significant limitations that must be carefully considered:
- Loss of control — once a life estate deed is recorded the life tenant cannot sell, mortgage, or significantly alter the property without the consent of all remaindermen. This loss of control can be a significant drawback.
- Medicaid complications — creating a life estate within five years of applying for Medicaid may trigger a penalty period. Even outside the look-back period the rules regarding life estates and Medicaid vary significantly by state.
- Irrevocability — once a life estate deed is recorded it is generally difficult to undo without the cooperation of all remaindermen. If the life tenant’s circumstances change or the relationship with the remaindermen deteriorates reversing the deed can be problematic.
- Remaindermen’s creditors — because the remaindermen have a present legal interest in the property their creditors may be able to place liens on the property during the life tenant’s lifetime
- Property taxes and capital gains — the tax implications of a life estate are complex and depend on the specific circumstances. Consulting with a tax professional is advisable.
Life estate vs living trust
Both a life estate and a revocable living trust can be used to transfer property to heirs while avoiding probate but they have important differences:
- Control — a revocable living trust allows the grantor to maintain full control of the property and change or revoke the arrangement at any time. A life estate significantly restricts the life tenant’s control once the deed is recorded.
- Flexibility — a living trust is more flexible than a life estate and can be modified as circumstances change. A life estate deed is difficult to change once recorded.
- Privacy — a life estate deed is recorded in public land records. A living trust is a private document.
- Cost — a life estate deed is generally less expensive to create than a living trust. However the limitations and potential complications of a life estate may outweigh the cost savings.
- Medicaid planning — both tools can be used in Medicaid planning but the rules are complex and state-specific. An elder law attorney can advise on the best approach for your situation.
Enhanced life estate — Lady Bird deed
An enhanced life estate — commonly called a Lady Bird deed — is a special type of life estate available in some states including Florida, Michigan, Texas, Vermont, and West Virginia. Unlike a standard life estate a Lady Bird deed allows the life tenant to retain full control of the property including the right to sell, mortgage, or transfer the property without the consent of the remaindermen.
A Lady Bird deed provides the probate avoidance benefits of a standard life estate while preserving the life tenant’s full control of the property. It is also generally more favorable for Medicaid planning purposes than a standard life estate in states where it is available.
Medicaid and life estates
The interaction between life estates and Medicaid is complex and varies significantly by state. Key considerations include:
- A transfer of a home into a life estate within five years of applying for Medicaid may trigger a penalty period under the look-back rules
- In some states the value of the life estate interest retained by the life tenant is counted as an asset for Medicaid purposes
- Medicaid estate recovery rules vary by state — in some states Medicaid can recover from the life tenant’s interest in the property after death
- A Lady Bird deed may be treated more favorably than a standard life estate for Medicaid purposes in states where it is available
Because of these complexities anyone considering using a life estate for Medicaid planning purposes should consult with an elder law attorney who is familiar with the rules in their state.
How to create a life estate
Creating a life estate involves:
- Working with a real estate attorney or estate planning attorney to draft a life estate deed
- Clearly identifying the life tenant and all remaindermen in the deed
- Having the deed signed and notarized by the life tenant
- Recording the deed with the county recorder or register of deeds in the county where the property is located
It is important to work with an attorney to ensure that the deed is properly drafted and recorded and that you fully understand the implications of creating a life estate before proceeding.
Key terms to know
- Life estate — a form of property ownership in which a person has the right to use property for their lifetime after which ownership passes to the remaindermen
- Life tenant — the person who holds the life estate interest and has the right to use the property during their lifetime
- Remainderman — the person or persons who receive full ownership of the property when the life tenant dies
- Life estate deed — the legal document that creates a life estate
- Lady Bird deed — an enhanced life estate that allows the life tenant to retain full control of the property
- Step-up in basis — an increase in the tax basis of inherited property to its fair market value at the time of inheritance
- Medicaid estate recovery — the process by which a state seeks reimbursement from a deceased Medicaid recipient’s estate
Sources
- American Bar Association — Public Resources
- National Academy of Elder Law Attorneys — naela.org
- USA.gov — Estate Planning
This article is for general informational purposes only and does not constitute legal advice. Life estate laws and Medicaid rules vary significantly by state. Consult a licensed attorney for guidance specific to your situation.