Transferring Real Estate to Heirs, Part 4

One of the more frequent estate planning conversations we hear centers upon the transfer of real estate from a person to his-or-her heirs (usually children). This is the fourth in a series of posts reviewing some general information on doing that. As we are typically talking about “the house”, this post will refer to “your house”, but everything here applies to any real estate.

In the previous posts we have considered what happens to property that you own with others (“concurrent interests” if you like fancy-shmancy legalisms), and we talked about leaving property to others through your will (called a “devise”), a trust, and what happens if you have no will or trust.

This brings us to a consideration of Life Estates. There is the traditional life estate discussed here, and next time we will discuss the enhanced life estate.

Traditional Life Estate Deed. You could do execute a Life Estate Deed under which you retain the right to possession and enjoyment for your lifetime, and upon your death (or the death of the surviving spouse), the remainder (what is left after your life estate terminates) will pass to the child/ren (here known as the “remainderman”, whether one or more) when you die. Usually this is just called a “Life Estate”, we are calling it “Traditional” to distinguish it from the “Enhanced Life Estate” which we will discuss next time.

Life estates are quite old, and divide ownership based upon time. Person A owns until a certain named person (who may or may not be person A) dies, after that Person B owns. So I could give a house to Mary for the life of Mary, then to Susan. Susan gets the house when Mary dies, but Susan owns that part of the house NOW. (Even though Mary is alive and Susan has no right to even be in the house now.) So Susan’s interest, which is called a “remainder”, is “vested”. This will be important when we get to Enhanced Life Estates, but it also can have implications for taxes and liens.
The remainderman can be one person, multiple people (in equal or unequal shares), or a trust.

PROS:
• There is no probate (with respect to the property) when you die.
• The transfer will be clear of all of the creditor problems you may develop in the future, including Medicaid Estate Recovery. Bullet-Proof. In fact, the ONLY thing that is without using a trust. (But if you are having trouble with creditors when you make the transfer it may not protect the house from them.)
• This type of transfer will not disqualify you for Medicaid IF: the deed meets certain technical requirements AND IF EITHER a) the child or children actually pays you FMV for their interest in the property (there are tables for calculating this amount), OR b) the transfer happens MORE than sixty months before you need Medicaid.
• The Remainderman receives a step-up in basis if they receive the property when you pass away (but NOTE that if you decide to sell before you pass away they could owe capital gains tax).

CONS:
• Your child OWNS a vested future interest in your house. He or she has no present interest and can not throw you out, or even be there without your permission while you are living, but the transfer of the future interest is irrevocable (unless your child signs a deed).
• If you gift the interest (as defined by the IRS), you will probably have to file a gift tax return (though this does not necessarily mean tax would be owed).
• If there is a gift, and if you (or your spouse) need Medicaid in the following 60 months, you will face a penalty in the form of a waiting period during which you are ineligible for benefits.
• As a practical matter, you cannot sell your house without your child’s consent (signing the deed) AND, if he or she is married, the spouse signing as well.
• As a practical matter, you cannot borrow against your house without your child’s consent (signing the deed of trust and, probably, the note) AND, if he or she is married, the spouse signing as well.
• Your child OWNS a future interest in your house, so if he or she has creditor problems, the creditors may get that portion of your house (but not as long as you are alive). If this is an issue, you could establish an irrevocable trust to serve as remainderman.
• If your child has any income tax liens or judgment liens against the child’s share, they must be cleared before the property could be sold. If this is an issue, you probably should establish an irrevocable trust to serve as remainderman.
• If your child dies before you, the remainder interest goes to her or his heirs, and there will be nothing you can do about it. (Whereas with an Enhanced Life Estate, will, or trust you could change the documents.) Again, if this is an issue (e.g., “family land”), you could establish an irrevocable trust to serve as remainderman.
• If you own a condo, association approval may be required.

As always, this conversation is of a general nature and is NOT A SUBSTITUTE for coming in and discussing YOUR PARTICULAR SITUATION with us. We will offer you coffee, and we rarely bite. Also, this conversation is based on North Carolina law at the time it was written, and assumes that both you and the real estate in question are in North Carolina. Mobile homes can cause additional complications that are not addressed here. Next time, we will discuss enhanced life estate deeds and a bonus topic. Until then…