A life estate in property is a curious ownership structure. The structure includes two distinct owners. The first is called the life tenant and the second is called the remainderman. The life tenant can use the property during his or her life in the same way that he would if there was no remainderman with one important exception. That is; immediately upon the life tenant’s death, the remainderman gets the full use of the property.

Life estates can be very useful tools in estate planning. They can prevent the home from going to probate. They can help with Medicaid planning. However, because of their distinct ownership structure, a life tenancy can result in very curious tax results.

Consider this: Mother decides she would like to make a gift of her home to her son, but she would like to remain in the home until her death. As such, at the age of 70, in April of 2010, she deeds the home to her son and reserves a life estate to herself.

At that time, Mother has made a gift to her son that is equal to his ownership interest in the home. This ownership interest is calculated based upon IRS actuarial tables that estimate the average life expectancy of an individual. Pursuant to IRS actuary tables, Mother owns 34.320% of the home and son owns 65.680% of the home as a result of the transfer. If the home is worth 100,000 at the time it is deeded to Son, Mother has made a gift in the amount of $65,680.00. This amount is not eligible for the annual gift tax exclusion because Son will not have use of the home until after his Mother dies; it is not a current gift. Fortunately, most American’s do not need to be concerned about this gift tax issue as there is currently a lifetime exclusion of more than five million dollars that makes it unlikely any gift tax will need to be paid on a transfer of this nature.

There is a chance that the life estate will result in capital gain taxes. This would occur if Mother and Son decide they would like to sell the home. The gain on the sale would be calculated based on Mother’s basis in the home (usually the amount she paid for the home). The gain would be divided by Mother and Son based upon their ownership percentages. Most likely, Mother would not have to pay capital gains tax on her portion because she would likely be eligible for the homeowners exclusion. Son, on the other hand will probably have a taxable gain unless he lives with his Mother.

Curiously, the above stated ownership percentages are not stagnant. As Mother gets older, the actuarial tables change and her ownership percentage in the home gets smaller and smaller as her Son’s ownership percentage grows.

Additionally, when Mother passes away, the entire interest of the home is included in her taxable estate because she retain the beneficial interest in the home during her life. This can be a very good thing because it also means that the Son receives a stepped-up basis in the home. Thus, if he chooses to sell the home after his mother passes, his gain would be calculated based on the fair market value of the home at the time of Mother’s death rather than Mother’s basis as it was if the home would have been sold during Mother’s life.

As with all estate planning tools, the life estate can be very useful for accomplishing complicated goals. However, even the simplest tools require a learned practitioner to assist you in proper use. Please contact us or call us at (573)686-2459 to discuss your estate planning needs.