A Life Estate in Real Property
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A life estate is a real property interest for life, after which the property reverts back to the owner, his family, or a designated third party. It is a possessory interest in which the life tenant has the right to use and benefit from the property. The party that receives the remainder of the life estate is known as the remainderman. Modern day life estates can be the standard life estate or life estate pur autre vie. The standard life estate lasts for the duration of the life of the person occupying the property. The life estate pur autre vie is based upon the life of a third person. Both types of life estates 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, his family, or a designated third party.
Creating a Life Estate
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.
Advantageous Use of a Life Estate
Life estates are not commonly used in practice because the concept has been replaced by living trusts.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 beneficial use of a life estate is for 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, the recorded value of the property changes when the life estate starts. Upon your grandfather's death, as an heir, you get the advantage of this step-up basis on the decedent's property. As a planning tool, the life estate is also useful to avoid probate. Probate is the legally required process that transfers property from a deceased person to his descendants. A life estate is an instant transfer, similar to life insurance, so probate is not required.
Tax Consequences of Using a Life Estate
Under Federal Estate Tax Code Section 2036, a life estate is a gift. This means that if the property is valued at more than $14,000, a gift tax must be paid. A life estate with a value of less than $5.25 million dollars does not have an estate tax attached, as of 2013. Finally, if a house is sold after a life estate ends, there is little to no net gain that must be reported on taxes because of the value step-up.
If your total assets including the property are worth more than $1 million dollars, or your property is in a different state or country, consult an estate planning attorney for advice before drafting a life estate. Certain countries do not recognize life estates and a lawyer will have better options to help you avoid superfluous tax costs.