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Senior couple working on a life estate deed

A life estate deed can offer creditor protection, tax benefits and avoid probate

by Curtis Lee | Contributor
November 25, 2021

A life estate deed is a legal instrument that gives an individual the right to use real property while they're still alive. But upon that individual's death, the property will automatically transfer to a designated beneficiary without having to go through probate. There are other benefits and drawbacks of life estate deeds, especially when compared to an irrevocable living trust.

An irrevocable living trust (sometimes known as an ILT), is very popular for estate planning purposes. Not only does it help you keep assets out of probate court, but it also can protect assets from creditors and reduce taxes. But ILTs have their fair share of disadvantages.

One of the biggest drawbacks is that the creator of the trust no longer controls the assets placed in the trust. Instead, a trustee decides how the property should be used. And while you can create a trust where you're the beneficiary, you're still relying on the trustee to use the trust property in a manner that you desire. This is because you have no legal right to force a trustee to administer the ILT the way you tell them to.

One alternative to ILTs is the life estate deed. Depending on your estate planning needs, these can offer some protection against creditors, a few tax benefits and help avoid the probate court process. Let's take a closer look at life estate deeds and see what sort of benefits and drawbacks they offer.

What's a life estate deed?

A life estate deed is a special deed that creates a life estate legal interest in real property. A life estate is a right in real estate that gives the life tenant the right to use and live on the property until they die. Immediately after they pass away, the property transfers to the beneficiary (also known as a remainderman). The beneficiary then becomes the full owner of the property. Let's look at an example to better explain how life estate deeds work.

Janice owns her home and wants to pass it on to her son, Finn, when she dies. Using a life estate deed, Janice becomes the life tenant. While she's alive, she can continue living in her home and using it as she always has. Yet there are some limitations in how she can use her property, which we'll get to later. Also, during this time, Finn only has a “remainder interest” in the property. He has no practical means to use the property, as he has no legal right to live there or use it.

As a life tenant, Janice must continue paying property taxes and is liable for any other costs associated with homeownership. For instance, if she wants her home insured, she's responsible for purchasing a homeowner's insurance policy and paying the premiums.

After Janice dies, her life estate immediately ends and her home does not become part of her estate. Instead, Finn becomes the brand new legal owner of the property. His legal interest is not a life estate. Rather, he has a fee simple interest in the home. This means he owns it outright, with no limitations or conditions on what he can do with it.

Of course, if the property has been subject to easements or covenants, Finn would have to honor those. But the bottom line is that Finn does not get a life estate. He can sell the home, mortgage it, lease it or anything else the typical homeowner might want to do.

Why you might benefit from using a life estate deed

Besides the streamlined process of transferring property to a beneficiary upon the life tenant's death, there are plenty of benefits for using a life estate deed.

First, life estate deeds allow the property to avoid probate. Instead of including the home as a part of the deceased's estate, it simply transfers to the beneficiary. No will, trust or other legal document is necessary to make this transfer happen. All the beneficiary needs to do is file the life tenant's death certificate in the public record.

This seamless nature of the property transfer can be very reassuring to life tenants. Maybe they fear a will contest from a disinherited family member. Or they're afraid creditors might go after the property. But with a life estate deed, a life tenant can be confident that the life estate deed will protect the property in a variety of scenarios.

Second, life estate deeds allow life tenants to continue enjoying the property (subject to certain limitations). There's no need for the life tenant to rely on the hope that the trustee of an ILT can be relied upon to administer the trust property in a way that coincides with the life tenant's preferences and wishes.

For example, let's look at a hypothetical home that's placed in an ILT as opposed to using a life estate deed. Instead of being the life tenant, an individual wishing to still live in the home will be the beneficiary of the ILT. And instead of the ILT's beneficiary deciding how to use the home, it will be an ILT's trustee.

So what happens if the beneficiary of the ILT wants a new roof? They have no legal right to purchase one unless the trustee consents to the home upgrade. This could cause problems if there's disagreement on what kind of new roof to install or how much it should cost. Even if no disagreements occur, there's the added hassle of getting a second person involved in the roof buying process.

With a life estate deed, the life tenant can choose the roofing contractor themselves. With an ILT, the trustee would have to serve as an intermediary between the beneficiary living in the home and the roofing contractor.

Handing over house keys

Third, life estate deeds are fairly simple, at least compared to other estate planning legal instruments like an ILT. With an ILT, there will be additional parties involved in addition to the beneficiary, such as a trustee. Also, the trustee must administer the ILT, so there's a constant need for someone to do something with the trust.

In contrast, once the life estate deed gets executed, there's generally nothing else anyone needs to do until the life tenant passes away.

Fourth, life estate deeds are useful for Medicaid planning purposes. Specifically, it can shield an asset from Medicaid estate recovery.

Medicaid is a health care program administered by states and funded by both states and the federal government. It provides health coverage to low-income and other special needs individuals. This includes helping pay for a nursing home or other assisted care services.

To help keep Medicaid funded, states are required by federal law to try and recover Medicaid money paid out to recipients who receive long-term care services. Medicaid estate recovery applies to individuals who began receiving Medicaid benefits when they were 55 or older. It also applies to anyone who has been permanently institutionalized, regardless of their age.

After a Medicaid estate recovery-eligible individual passes away, the state will become a creditor during probate. They will try to recover from the deceased's estate the money the state paid for the deceased's long-term care services. This could include going after a primary residence or other real estate property of the deceased.

Several exceptions prevent a state from using Medicaid estate recovery to pursue the deceased's home. The biggest one is if an eligible individual is still living in the home when the Medicaid recipient passes away. Eligible individuals include:

  • A child who is less than 21 years of age
  • A spouse
  • A child of any age who is disabled or blind
  • A sibling with a legal interest in the home and who has been living in the home for a certain period of time

Unless one of those exceptions applies, Medicaid recipients will want to use an estate planning tool to prevent Medicaid estate recovery of their homes, such as an ILT or life estate deed.

If a home is placed in an ILT or subject to a life estate deed, the state can't go after the property. With an ILT, the home did not belong to the Medicaid recipient at the time of death and they had no legal interest in the property. With a life estate deed, property never becomes part of the deceased's estate during the probate process. Therefore, the state can't go after it in probate as a creditor.

An individual can choose to use an ILT instead of a life estate deed to prevent Medicaid estate recovery. But life estate deeds are simpler to create and use and they don't require a trustee.

Reasons to avoid using a life estate deed

It's clear that life estate deeds offer a host of advantages that make them a great alternative to ILTs. But just like ILTs, there are drawbacks that you need to be aware of before creating a life estate deed.

First, life tenants lose the ability to do anything they want with the property. Unless the life estate deed says otherwise, the life tenant can make modest upgrades to the property, such as painting it, making repairs or renting it out for the weekend. However, the life tenant can't sell the property or mortgage it unless they first get permission from the beneficiary.

Basically, any major decision concerning the property must first get approved by the beneficiary. And if the life tenant wants to change who the beneficiary is or end the life estate, they'll also need the beneficiary's permission. Even if the beneficiary agrees to what the life tenant wants, there could be other unintended consequences. For example, if the parties agree to sell the property, the proceeds are split between the life tenant and the beneficiary.

Second, the property is subject to the beneficiary's liability. If the beneficiary gets into money trouble, the beneficiary's creditors may file a lien on the remainder interest the beneficiary has in the property. This could cause some headaches for the life tenant.

Third, a life estate deed isn't possible if the property is subject to a mortgage. For older individuals who may already own their home or other real estate outright, this shouldn't be a problem. But if the property is still serving as collateral for a mortgage, a life estate deed isn't possible.

Fourth, there are situations where the property won't go to the beneficiary as planned by the life tenant. For instance, if the beneficiary dies before the life tenant, the property could transfer to someone the life tenant never intended.

What happens when a beneficiary dies before the life tenant is that the remainder interest the beneficiary had will go to the beneficiary's heirs. Then when the life tenant dies, the property passes to the beneficiary's heirs as outlined in a will, trust or intestate laws of the beneficiary.

While the beneficiary was still alive, it would have been possible, at least theoretically, to prevent this from happening. The life tenant and beneficiary could have had a meeting to deal with the situation the beneficiary passes away before the life tenant.

Special arrangements could have been made in the beneficiary's will or in the life state deed to ensure the property passes to an alternative beneficiary that the primary beneficiary and life tenant can agree to. But if the beneficiary dies before these arrangements can be made, then the life tenant is largely stuck with whatever the intestate laws, will, trust or other estate planning instrument says who the heirs will be.

If there are multiple beneficiaries and other parties of interest, like the spouse of the life tenant or stepchildren, things can get very complicated (and expensive) very quickly. And in the end, instead of the property transferring as intended by the life tenant, the property could get sold so it can be divided among the various individuals with a legal right to it.

Bottom line

Life estate deeds offer individuals a powerful estate planning tool. Then when they die, the property can pass on to the beneficiary of their choice without being subject to probate or Medicaid estate recovery. The irrevocable living trust can achieve similar goals, but it's more complex to create and administer.

But the life estate deed isn't without its drawbacks, including limitations on major decisions concerning the property, the beneficiary's interest in the property being subject to creditors and the fact that life estate deeds won't work if the property is subject to a mortgage.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

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Email - info@legacyassuranceplan.com

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