A life-estate is a way to hold property which allows the person with the life-estate to hold the property for the duration of a single life, then give it back to the owner, their family, or a designated third party. It is a possessory interest, the life-estate holder is called the life tenant and has the right to use and benefit from the property. The party that receives the remainder of the life estate is sometimes called the remainderman.
There are two types of modern life estates. The first is a standard life estate and lasts for the duration of the life of the person occupying the property. The second type of life estate is based upon the life of a third person. This life estate, invented in France, is referred to as a life estate pur autre vie. Both of these life estate types accomplish the same goal of giving the property to someone for the duration of a single life, and then giving the property back to the original owner, their family or a designated third party.
Modern Application
Life estates are not commonly used in practice because the concept has been replaced by living trusts. However, this archaic form of inheritance can serve some very useful purposes. The most useful benefit of a life estate is the adjustment of property value, referred to as a “value step-up.” The value step-up allows a net change in the actual value of a property. For instance, if your grandfather purchased his farm for $20,000 in 1940 but the current value is $550,000, then the recorded value of the property changes when the life estate starts.
Life estates are also useful if you want to avoid probate. Probate is the legally required process that transfers property from a deceased person to their decedents. A life estate is an instant transfer, similar to life insurance, so probate is not required.
Tax Consequences
Under the Federal Estate Tax Code Section 2036, a life estate is a gift. This means that if the property is valued at more than $33,000, a gift tax must be paid. A life estate with a value of less than $1 million dollars does not have an estate tax attached, as of 2010. Finally, if the house is sold after the life estate is finished, there is little to no net gain that must be reported on taxes because of the value step-up.
Creation
Life estates are created through re-drafting the property's deed to specify that it is a life estate with the remainder passing in fee simple to someone else. As with all property transfers, the deed must be signed by both parties, notarized and filed with the state’s recording office.
Cautions
If your total assets including the property are worth more than $1 million dollars, or your property is in a different state or country seek an attorney's advice before drafting a life estate. Certain countries do not recognize life estates and an estate planning attorney will have better options to help you avoid superfluous tax costs.