The term “life estate” often comes up in discussions of estate and Medicaid planning. Life estates can be used to avoid probate and to give a house to children while retaining the ability to live there. Life estates also can play an important role in Medicaid planning. But what, exactly, does the term mean and how are life estates used?
A life estate is a form of joint ownership that allows one person to remain in a house until his or her death, when it passes to the other owner. Two or more people each have an ownership interest in a property, but for different periods of time. The person holding the life estate – the “life tenant” – possesses the property during his or her life. The other owner – the “remainderman” – has a current ownership interest but cannot take possession until the death of the life estate holder. The life tenant has full control of the property during his or her lifetime and has the legal responsibility to maintain the property as well as the right to use it, rent it out and make improvements to it.
When the life tenant dies, the house will not go through probate, since at the life tenant’s death ownership passes automatically to the holders of the remainder interest. Because the property is not included in the life tenant’s probate estate, it can avoid Medicaid estate recovery in states that have not expanded the definition of estate recovery to include non-probate assets. Even if the state places a lien on the property during the life tenant’s life to recoup Medicaid costs paid on his or her behalf, the lien will only be for the value of the life estate, not the full value of the property.
However, although the property will not be included in the probate estate, it will be included in the taxable estate for estate tax purposes. Depending on the size of the estate and the state’s estate tax threshold, the property may be subject to estate taxation.
The life tenant cannot sell or mortgage the entire property without the agreement of the remainderman. If the property is sold, the proceeds are divided up between the life tenant and the remainderman. The shares are determined based on the life tenant’s age at the time and may factor in current interest rates – in general, the older the life tenant, the smaller his or her share.
Be aware that transferring your property and retaining a life estate can trigger a Medicaid ineligibility period if you apply for Medicaid within five years of the transfer. However, purchasing a life estate should not result in a transfer penalty if you buy a life estate in a family member’s home, pay a fair amount for that interest and live in the house for at least one year before applying for Medicaid. To find out if a life estate is the right plan for you, consult with an attorney who has experience with your state’s Medicaid laws.