What is a life estate and will it allow you to maintain control and avoid probate

What is a Life Estate? 

A life estate is an interest in real property which lasts only for the duration of a specified person’s life, usually the possessor, who is otherwise known as the “life tenant”. The life tenant normally maintains the absolute and exclusive right to use the property during his or her lifetime.

While the life tenant doesn’t maintain ownership interest in the property, he or she is nonetheless responsible for the upkeep of it including, paying the real estate taxes, insurance, and any other costs associated with the property. The life tenant, however, is also entitled to all of the income that the property produces in the event that it’s an income producing property.

The individual or a group of individuals who becomes the owner of the property upon the death of the life tenant(s) is known as the “remainder owner(s).” The remainder owner(s) doesn’t have a right to use or enjoy the property during the life tenant’s lifetime and is therefore not responsible for the payment of taxes and other maintenance costs associated with it. There can be more than one life tenant and remainder owners for a particular piece of property.  Your attorney can draft a “life deed” with fairly broad language provided that it doesn’t violate federal or state law.  

Can a life estate help you avoid probate?

While many believe that a life estate will help them avoid probate (i.e. inheritance taxes and administrative fees), property that is subject to a life estate is still potentially taxable for federal estate and inheritance tax purposes.  Under Pennsylvania law any property transferred in which the transferor expressly or impliedly reserves a life estate is subject to Pennsylvania inheritance tax.

The value of the life estate for inheritance tax purposes is based on actuarial assumptions used for federal estate tax purposes by the IRS. For example, if a parent maintained a life estate in a property worth $100,000.00 on the date of death at age 70 the value of the life estate would be $60,522.00 while the remainder interest would be $39,478.00.  These figures are based on the Life Estate Valuation Table.  If you look at these figures, you can see that the remainder interest, which is the amount subject to the inheritance tax, increases as the life tenant ages.

It is an asset transfer

Please remember that if you choose to create a life estate in a home or any other piece of real estate, it’s an asset transfer!  You must change the deed to the property in order to create a life estate and the new deed must be recorded.  In Pennsylvania, if the transfer is made within one (1) year of death, it’s not recognized for inheritance tax purposes.  The law assumes that you made the transfer because you knew that you were dying and you wanted to save your heirs the inheritance tax.  In addition to this one (1) year look back period for inheritance tax purposes, there is also a five (5) year “look back” for Medicaid purposes that I discussed earlier.  

If you want to create a life estate, the very first question must be WHY!  In some situations, it may be very good option but you need to discuss it with your estate planning attorney and your financial advisor to ensure that it fits with the rest of your estate plan.  

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[i] The Pennsylvania Department of Revenue; The Internal Revenue Service