Life Estate Warnings

We are often asked to do deeds conveying the homestead of an elder to his/her children to "avoid probate" or to "avoid medical assistance". The following is a summary of reasons why this might not be a good ideal: When you create a life estate, a gift is automatically made to your children. The gift is known as the remainder interest. This gift disqualifies you for medical assistance (help with nursing home bills) for a period of time not exceeding 60 months. Sufficient cash assets must be reserved to pay for nursing care during that time.

  1. If you wish to sell or mortgage your property, it may be awkward because all of your children and their spouses, must sign the deed or mortgage.
  2. If any of your children have a judgment or tax lien it may well attach to their remainder interest. This will usually mean that it must be satisfied before the property can be sold or mortgaged, resulting in a loss to your child. If a child later develops financial problems and files bankruptcy, he or she will lose their remainder interest and you will be dealing with the bankruptcy trustee.
  3. If any of your children have marital problems, which end in divorce, their remainder interest will figure in your child's property settlement.
  4. In the event of a sale of the property before your death, if there is a taxable gain, your children will have to pay ordinary income tax on a portion of the gain.
  5. In the event of a sale of the property during your lifetime, your children will receive part of the sale proceeds and they will have no legal obligation to return any portion of it to you.
  6. If you are receiving nursing care and the property is sold, it will be necessary to use a portion of the sale proceeds to pay for your nursing care expense.
  7. If any of your children die before you, it will be necessary to probate that child's estate. Usually, a remainder interest owned by a deceased child will go to his or her spouse, if they are married.
  8. The property will be included in your taxable estate for estate tax purposes.
  9. In the event of a sale of just your life estate or a sale by just one of your remainder-men. You will run into the so – called term interest rule which means that no income tax basis is allowed on the sale and the entire sale price is treated as taxable gain.
  10. If, at any time, you want your children to give back their remainder interest, it might have a harmful effect on your children because the gift back to you will probably be regarded as a future interest and, therefore, part of their unified credit will be lost. This may have a harmful effect on your children's estate tax situation at the time of their death.
  11. There is another option. It is a Transfer on Death Deed. This deed must be recorded while the Grantor is still alive. It will not avoid a claim for Medical Assistance but it could avoid having a probate proceeding.
In Estate Planning, one size does not fit everyone. We must look at the entire picture before charting a course of action.