Creating a life estate in Massachusetts can help protect your investment in your home, keep an important asset in the family and reduce your estate for MassHealth eligibility. However, life estates are not right for everyone. Here is a primer on what you need to know before considering whether creating a life estate could be a good option for your family.
What is a Life Estate?
A “life estate” is an interest in real property that is limited to the duration of an individual’s life (the life tenant), after which the property transfers automatically to a second party (the remainerman). The life tenant, during his or her life, retains use and possession of the property, including the rights to rents and profits, and is also responsible for the costs of maintaining the property. The life tenant cannot sell or waste the property, however, without the consent of the remainderman.
A life estate is created by conveying the property by deed to the remainderman which also carves out a life estate for the grantor. The “remainder interest,” i.e. the remainderman’s ownership of the property, will take effect immediately upon the death of the life tenant.
What Are some Benefits of Creating a Massachusetts Life Estate?
1. A life tenant has the legal right to remain in their house for as long as they live. Otherwise, if the house was transferred outright, the new owner could legally sell the property the next day forcing the previous owner to vacate the premises. A life estate offers security in your home.
2. When the life tenant dies, the property immediately passes to the remainderman without the necessity of a probate proceeding, saving time and money for the family.
3. Creating a life estate can reduce your estate to help achieve MassHealth/ Medicaid eligibility and protects your home from MassHealth/ Medicaid liens and estate recovery.
Jane Doe, a 75-year-old widow, owns a home in Essex County, Massachusetts with a fair market value of $250,000.00. Her home is her most valuable asset which she wants to leave to her son. Jane has a progressive illness which renders her ineligible for long term care insurance. Therefore, she may have to apply for MassHealth as her health declines. By drafting a deed which retains a life estate for Jane with the remainder to her son, the following can be accomplished:
a. If Jane had transferred the house to her son outright, once she applied to MassHealth (assuming she applied within the 5-year look-back period) she would be assessed a disqualification period based on the property’s fair market value of $250,000.00. However, by retaining a life estate, only the value of the remainder interest would be considered a potentially disqualifying transfer. The value of the remainder is determined by the prevailing interest rates and the Social Security life expectancy tables. Since Jane is transferring a future interest, which is worth much less than the present full value, her disqualifying transfer will be greatly reduced and she will be eligible to receive MassHealth considerably sooner.
b. MassHealth regulations limit recovery to probate assets of the Medicaid recipient or her spouse (in our example Jane is a widow). Since the life estate is extinguished upon Jane’s death, the property passes to her son out of probate and is therefore not recoverable by the state. Any lien placed on Jane’s life interest will, along with her life estate, become void when she dies.
4. The life tenant remains the owner during life, and therefore continues to qualify for any property tax reduction available to the “owner” of the property.
Are There Tax Ramifications of Creating a Life Estate?
Pursuant IRS regulations the gift tax value of transferring a remainder interest is the full value of the property, without any discount. Therefore, in the above example for gift tax purposes Jane transferred her home valued at $250,000.00, even though she created a life estate. However, in 2012 Massachusetts residents have a $1 million state gift/estate tax exemption and a $5 million federal gift/estate tax exemption. This means that Jane would have to file a gift tax return reporting that in the transaction, she utilized $250,000.00 of her federal and state tax credit. However, she would not have to pay any federal or state gift taxes as long as she had not made other large gifts which collectively surpassed the federal and state tax credits.
Are Life Estates for Everyone?
The ideal candidate for a life estate is someone who wants to live in their home for the rest of their life and would never sell. Other appropriate candidates are those who are ill and need the reduction in the MassHealth disqualification period afforded by the life estate. Individuals with larger estates with significant estate tax exposure should consider other options, such as the Qualified Personal Residence Trust. The life estate is only one of many estate planning and asset preservation tools, so it is important to consult with an attorney prior to choosing which course is right for you.