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What are the benefits of a life estate in a Warranty Deed?

Over six years ago, my parents transferred their home to me (I'm the only child) for $10.00 so I thought I was the sole owner of their home. What I did not understand was the clause in the Waranty Deed as follows: SUBJECT, HOWEVER, to the life estate reserved to (Dad) and (Mom), husband and wife, as set forth in deed filed as Document No. XXXXX. My dad passed away that same year in 2009 and now this home has become a rental since 2013 after my mom moved in with me. I have been a full-time caregiver since December 2012 and do not work. How does this life estate help me in my position whether I decide to keep or sell my childhood home? I do understand that I will inherit the home when my mom passes away without going through probate but will it be tax free?
Status: Open    Sep 01, 2015 - 08:01 AM

Elder Law

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Sep 02, 2015 - 09:52 AM

First, the answer to this question may vary depending on the state you are in; so, I recommend that you talk with an elder lawyer in your area for specific advice. However, in Alabama, a life estate is not considered to have a value for Medicaid purposes. This means if your mother later needs to go to a nursing home, the land will not be considered her asset and you will not be forced to sell it or subject it to a lien (this is not true in all states).

One of the benefits of a life estate is that your mother remains responsible for property taxes while she is living because she has reserved the life estate. This means that you do not have to pay the taxes. Generally, the parent has homestead rights on the property and may pay little to no taxes on the property. As such, this can be a plus for all parties.

A life estate also provides a step-up in tax basis for you at your mother's death. In other words, your tax basis for capital gains tax purposes is equal to fair market value at the time of her death instead of what she paid for the land plus any improvements added to the land. This can mean the difference in thousands of dollars of taxes. A simplified example is as follows: John and Mary purchased their homeplace for $25,000 in 1950. They have maintained the home but not added any improvements. However, the values of homes in the area have increased and the fair market value of their home is now $100,000.00. They deed the homeplace to their daughter, Sally, in 2000; but, reserve a life estate. John dies in January of 2015 and Mary dies in March of 2015. Sally's tax basis will be $100,000.00 (the FMV in 2015). She sells the homeplace for $100,000.00 and is not subject to any capital gains taxes. Conversely, if John and Mary deeded the house to Sally in 2000 without reserving a life estate, Sally's tax basis will be $25,000.00. When she sells the house for $100,000.00, she makes a profit of $75,000.00. Sally will pay capital gains taxes on the $75,000.00. So, you can see that the life estate can be beneficial for multiple reasons.

However, a life estate is not always the answer and may not be appropriate in some states. Consult with a local elder law attorney regarding federal and state estate taxes, Medicaid treatment of life estates, etc.

Sep 02, 2015 - 10:53 AM

Your mother's retained life estate allows you to get a stepped-up tax basis on her death. But, depending upon what State you live in, it may subject the property to Medicaid Estate Recovery when she dies if she uses Medicaid to pay for nursing home care. Check with a local Elder Law Attorney.

Sep 04, 2015 - 01:56 PM

Transferring ownership of a property through a Warranty Deed with a reserved life estate is a technique many attorneys will use to assist their clients with planning for their estate. As alluded to in your question, the deed transfer will most likely avoid the necessity to probate a Will to facilitate the transfer of the home from Mom to you at the time of her passing. As a result, once Mom passes away, you will be considered the owner of the property, and would therefore, have the ability to handle the property however you see fit, whether that means continuing to rent the property, move into the property, sell the property, etc. You may want to review these questions with an attorney licensed in the state where Mom's home is located to confirm this information. You may also want to review your mother's other assets to ensure that each asset is provided for in a further effort to avoid the probate process. Regarding potential tax ramifications with respect to inheriting the house, you may want to consult with your accountant regarding what if any taxes you will owe in the event your Mom passes away.

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