Understanding Life Estate Deeds: Benefits and Drawbacks

It’s possible to deed your property into a co-ownership with the person who will receive your home after your life. Perhaps you plan to leave your house to an adult child, or even a friend. A life estate deed is one option.

It keeps you in your home for life. After your life, your home bypasses probate, so your designated beneficiary receives it directly.

Here, we explore the elements of a life estate deed, how it works, and its potential pros and cons for older adults.

You Can Keep Living in Your Home for the Rest of Your Life.

As an older adult, you could decide to age in place. If you create a life estate deed, you’d live in your home just as you do now. You’d be called the life tenant. You’ll be bringing a co-owner onto the deed who’ll get the home after you pass on. That designated beneficiary holds what’s known as the remainder ownership. Your new deed must say the property goes to [your name] for life, then to [your beneficiary’s name] as the remainder.

If multiple people will have life interests or remainder interests, vesting the deed the way you want it is crucial.

You’ll sign the deed with a notary public. Record your new life estate deed in the county where your home exists. (Be prepared to pay a minor fee for the recording service.) Now, your legal ownership change is a matter of public record. This supports your beneficiary’s claim to the home when you have passed.

You can live in your home as long as you need it. Your beneficiary can’t move in (unless you both want that, and you agree to it).

You must maintain the home and pay the bills as long as you live in it. You’ll keep enjoying any tax benefits or homestead exemption you now have.

Let’s note one more attractive feature before we move on. After you pass, say your beneficiary wants to sell. They can — with a stepped-up tax basis (lowering capital gains taxes).

Impacts on Your Ownership Rights Can Be Potential Drawbacks.

A life estate does its key work after you’ve passed on. The deed proves your survivor’s ownership status, without having to go through the probate court. As you see, the life estate deed is a useful planning tool.

Now, what about potential drawbacks?

States may increase a property’s taxable value if a beneficiary is brought onto the deed. Also, creating a life estate deed rules out a Medicaid application for the following five years.

What’s more, when you bring a co-owner onto your home’s title, you’ll have to have that person sign off on any major moves you make that impact your home. This is the law’s way of making sure that your home’s future resident’s interest is protected.

Say down the road you want to sell. As co-owners on the deed, you must agree to sell together. You’ll divide the sale proceeds per the Internal Revenue Service rules.

And while you’ll keep your homeownership rights for life, you won’t have a crystal ball to tell you what your new co-owner will do. If your co-owner faces legal actions, a judgment or claim could be recorded against your now co-owned home.

Also, what if a younger remainder holder unexpectedly dies while you are alive? Know that you could wind up co-owning your home with your beneficiary’s heirs.

What Are the Alternatives? Here Are Some Other Deed Options.

Other states have similar tools. Ask a family lawyer or real estate lawyer in your state about your choices. Here’s what they could include:

• Does your state allow for enhanced life estate deeds (“lady bird deeds”)? Seniors in Texas, Florida, Vermont, Michigan, and West Virginia have been able to use lady bird deeds to shield their Medicaid eligibility when they transfer a part-interest in their homeownership. These deeds also let you sell or finance your home. You could also change your beneficiary. Your co-owner’s consent isn’t needed. It’s revocable, so an enhanced life estate won’t be subject to gift tax. But your property taxes could change.   

• Perhaps your state allows the transfer on death deed. You name a beneficiary, and can change your mind about the beneficiary if you wish. Your house will automatically pass, upon your death, to the person named on your current transfer on death document.

• Then there’s the revocable living trust. It can also bypass probate and convey the house to your beneficiary directly.

Revocable living trusts aren’t Medicaid recovery shields. But if your state places Medicaid liens on life estate property, such a claim will attach only to your smaller share of the home’s value — the life estate, not the remainder.

Of course, you could always just accept the probate process and pass your home along with your will.

A Life Estate Could Make Sense for Older Adults Who Intend to Live at Home On Their Terms…

This comes with the peace of mind in knowing the home is already passed along, legally, to a designated beneficiary. But it does have both benefits and possible pitfalls to weigh. Look to a local estates and trusts lawyer for guidance. And your tax pro can help you anticipate the deed’s potential impact on your tax returns.

PS: Got a mortgage? Hold off filing your life estate deed until you can get the lender to send you its advance written consent to the filing. This could be important later, should you wish to finance the home.