Taxes when You Transfer a Home to a Life Estate

A life estate is an arrangement by which the owner of a real property, such as a home, can transfer title but retain the right to live in the home. For example, an elderly parent may wish to transfer title to the home to a child, but wants to continue living in the home. With a life estate, the parent would continue to live in the home, pay the property taxes, insurance, repairs and maintenance, and generally could keep the applicable property tax exemptions or credits.

Full title to the home would pass to the child or children, referred to as the “remaindermen” upon the death of the parent. This generally avoids the need for the house to go through the probate process.

As pointed out on LawHelpMN.org, since the children would have an ownership interest in the home as a result of the life estate, that interest could be awarded to a spouse in case of a divorce. Or the child’s creditors could make a claim or place a lien on the child’s ownership interest in the home. If the parent decides that he or she would like to sell the home, the agreement of both the parent as life tenant and the child or children, as remaindermen, would be required.

There are gift tax and income tax consequences involved in a life estate. Transferring title to the child in a life estate is considered a gift for federal gift tax purposes. If the value is over the annual exclusion amount ($14,000 for 2013), the original owner, for example the parent, would have to file a gift tax return. But depending on other gifts the parent has made in his or her lifetime, it may be that no gift tax has to be paid, since there is currently (2013) a lifetime exclusion of $5.25 million.

As explained by the Law Firm of Bove & Langa, if the interest in the home that is being transferred meets certain criteria, it is a qualified interest. In this case the amount of the gift is calculated using IRS actuarial values based on the age of the parent at the time of transferring the interest in the home. Otherwise, the amount of the gift would be the full value of the home at the time.

If the parent who retains the right to live in the home decides to rent it out for any period of time, the parent would be entitled to the rental income and would be subject to income tax on the income less the allowable deductions.

If the home is sold during the parent’s lifetime, the parent, as the life tenant, would generally be able to exclude up to $250,000 of his or her share of the gain if he or she owned and lived in the property at least two of the last five years. The child or children as remaindermen would be subject to income tax on their share of the gain.

If the home is sold after the parent’s death, the basis in the home would generally be stepped up to the fair market value of the home at the time of the parent’s death. This could substantially decrease the gain on the sale that would be taxable to the child or children.

Sources:

Alexander A. Bove, Jr. and Melissa Langa, The Meaning of Life (Estates), Bove & Langa

Life Estate Ownership of Real Estate* (Advantages and Disadvantages), Berkshire Elder Law Center P.C.

Life Estates – Questions and Answers: Be Careful with Life Estates, LawHelpMN.org

Life Estates – Tax and Financial Issues, Lommen Abdo

Medicaid Planning: Life Estate Deed Transfer, Tully & Winkelman, P.C.

Publication 1457, Actuarial Values, IRS