The phrase "life estate" often comes up in discussions of estate and Medicaid planning, but what exactly does it mean? A life estate is a form of joint ownership that allows one person to remain in a house until his or her death, when it passes to the other owner. Life estates can be used to avoid probate and to give a house to children without giving up the ability to live in it. They also can play an important role in Medicaid planning.
In a life estate, two or more people each have an ownership interest in a property, but for different periods of time. The person holding the life estate — the life tenant – possesses the property during his or her life. The other owner(s) – the remainderman (or remaindermen if more than one) – has a current ownership interest but cannot take possession until the death of the life estate holder. The life tenant has full control of the property during his or her lifetime and has the legal responsibility to maintain the property as well as the right to use it, rent it out, and make improvements to it.
When the life tenant dies, the house will not go through probate, because at the life tenant's death the ownership will pass automatically to the holders of the remainder interest. Because the property is not included in the life tenant's probate estate, it can avoid Medicaid estate recovery in Pennsylvania upon the death of the life tenant.
Although the property will not be included in the probate estate, it will be included in the taxable estate. In Pennsylvania the property will be subject to Pennsylvania inheritance tax, which is the subject of another blog.
The life tenant cannot sell or mortgage the property without the agreement of the remaindermen. If the property is sold, the proceeds are divided up between the life tenant and the remaindermen. The shares are determined based on the life tenant's age at the time — the older the life tenant, the smaller his or her share and the larger the share of the remaindermen.
Be aware that transferring your property and retaining a life estate can trigger a Medicaid ineligibility period if you apply for Medicaid within five years after the transfer. Purchasing a life estate should not result in a transfer penalty if you buy a life estate in someone else's home, pay an appropriate amount for the property, and live in the house for more than a year.
For example, an elderly man who can no longer live in his home might sell the home and use the proceeds to buy a home for himself and his son and daughter-in-law, with the father holding a life estate and the younger couple as the remaindermen. Alternatively, the father could purchase a life estate interest in the children's existing home. Assuming the father lives in the home for more than a year and he paid fair value for the life estate, the purchase of the life estate should not be a disqualifying transfer for Medicaid. Just be aware that there may be some local variations on how this is applied, so be sure to check with your attorney.