“How a 'life estate' for your house works with your estate plan.”
It’s not unusual for a son or daughter to be granted a life estate on his or her parents' house. It’s also not uncommon for the child to consider the tax consequences for them, when the parents talk about moving.
NJ.com’s recent article, “What a 'life estate' means for your home,” discusses how this estate planning strategy works. A life estate gives the holder the legal right to possession of real estate.
The owner of the remainder interest also has an ownership interest in the property. However, the life estate holder has the right of possession.
The life estate holder can live in the property or rent it and keep the money. He or she is responsible for the maintenance and expenses of the property. At the life estate owner's death, the life estate expires, so it can’t be transferred to someone else.
The tricky part comes when you’re a life estate holder who is living in the home and it is sold: both the life estate holder and the remainder interest owner must agree to sell, because the buyer will want to take a 100% ownership interest and possession of the property.
The IRS has created life estate and remainder interest tables to figure out the value of each interest. The way it works, in general, is the older the life estate holder, the less ownership interest he or she will have and the more ownership interest there will be for the remainder interest holder.
If the home is sold, the proceeds must be divided between the life estate holder (usually the parent) and remainder interest owners (the child), according to the IRS tables. If the home has appreciated considerably in value, there may also be capital gains taxes that will be due.
The IRS rules state that if the life estate owner has lived in the home in two of the last five years before the home is sold, he or she can exempt up to $250,000 of capital gains from tax with the primary residence exemption. However, the remainder interest owner can’t use that exemption because he or she isn’t entitled to possession—they can’t claim it as a personal residence.
If the sale is being considered, talk with an experienced estate planning attorney to work out all of the legal details.
Reference: NJ.com (July 27, 2017) “What a 'life estate' means for your home”