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Martin Shenkman
Martin Shenkman
Private Life Estates

What every CPA must know.

October 22, 2009
by Martin Shenkman, CPA, PFS

Life estates are a commonly used estate and financial planning tool. In spite of the common use, many practitioners are not familiar with important nuances of the technique and how it might impact planning. Too often it becomes something implemented by the client's attorney with inadequate involvement of the client's accountant. A better understanding of the use of life estates and the tax and other issues it creates, can equip CPAs to become more involved when this planning technique is proposed and help their clients reach better decisions.

What Is a Life Estate?

A life estate is an ownership right or interest called an "estate" in land that lasts for the duration of a person's lifetime, hence the name "life-estate." The most common life estate is when the duration of the life estate is for the life of the person who holds the right to use the property.

Example: Joe shall have the right to use the house for the duration of Joe's life. It is possible to structure a life estate in which another person's life is the measure of the duration of the life estate. The use of different measuring lives can bring flexibility to planning.

Example: I grant to my mother-in-law Samantha, the right to live in the house at 123 Main Street, for the duration of my life. On my death, the ownership of the house at 123 Main Street, shall be given to the charity, "Elderly Witches Support Fund, Inc."

In the latter example the duration of the life estate is measured by someone other than the person using the property. In legal jargon this is called an "estate per autre vie."

Reader Note: The AICPA PFP Section has sponsored seminars and has material available for use with clients at the Estate Planning Awareness Week, October 19-23.

Reverse Mortgages; Home Equity Lines and Life Estates

Normally, the life estate holder does not have the right to mortgage or sell the property. This is a significant restriction that raises practical implications that should be addressed. Depending on state law and the terms of the deed creating the life estate an elderly parent, for example, might not have the right to use a reverse mortgage or other technique, thus precluding anticipated financial or other planning.

However, if the interests in the property are granted as a life estate with the right to sell or mortgage, the interest in the property may be re-characterized as an actual fee or complete ownership interest. This re-characterization could undermine other important planning goals. For example, if the life estate was created to insulate the home from a parent's medical costs, if the legal document creating the life estate permits the parent life-tenant to borrow on the property, re-characterization as a fee ownership could undermine the elder law planning objectives.

Obligations of Life Tenant

Too often life estates are considered as a "standard" or "simple" technique. This view is dangerously misleading. Practitioners should help clients understand what a life tenant is required by the document (instrument) creating the life estate or by law, to do. Life tenants generally have a number of obligations:

  • Not to commit waste. This means that the remaindermen who receive the property when the life tenant dies, may have a right against the life tenant if the property is not cared for.

    Example: Tom and Mary own a home. Mary Dies. Tom remarries Jane. Tom's will leaves Jane a life estate in the home on his death which provides that on Jane's death Tom and Mary's children, who have no positive feelings for Jane, will receive the property. The children band together to pursue Jane for not maintaining the property.

  • To make repairs. How can the life tenant and remaindermen differentiate a repair from a capital improvement? The potential for disputes is significant.

  • To pay property taxes and assessments.

Trust As a Better Alternative

Paying for the above items raises a considerable issue. The problem in many life estate arrangements is cash-flow. If the person — often a surviving spouse — does not have adequate resources to meet their obligations under the life estate, the condition of the property could deteriorate, the property could be lost or a dispute with the remaindermen can occur. In many cases when life estates are recommended or used, a trust would prove better (e.g., a QTIP (Qualified Terminable Interest Property)/marital trust if the life tenant is a surviving spouse). A trust can hold cash to help cover many of the expenses. A trustee has a clearly line of authority as to rights to act with respect to property. This relationship can often be less problematic then the vaguer standards applicable to a life estate.

Ancillary Issues

Life estate creates a host of issues that are too often completely ignored in the creation of these arrangements. Be certain to review the following with your client:

  • When does the life estate end? Logically, on the death of the person whose life is used as a measuring life. But is this really sufficient? What if your surviving second spouse is given a life estate, but she falls ill and moves into a nursing home. She might live for a decade or more in a nursing home but technically the house remains subject to her life estate. If a more comprehensive approach is used, issues such as this can be addressed.
  • What happens to tangible personal property, like art and furniture? Technically most life estates only cover the house involved. Many wills have boilerplate clauses leaving personal property to designated people. This might be the children from a prior marriage. The result can be explosive when a surviving spouse is left a life estate in the marital residence only to find that the children remove all the furniture and art.
  • Consider some type of mediation arrangement to resolve disputes between the life tenant and the remaindermen.

Conclusion

Life estates are a common estate and financial planning technique. Too often the simplistic approaches used do not address the many likely issues that can arise. Becoming more involved in guiding a client through better planning of life estate or using a trust can create tremendous benefits for those involved.

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Martin M. Shenkman, CPA, PFS, MBA, JD, is an attorney in Paramus, New Jersey and New York City. His practice concentrates on estate planning and administration, tax planning and corporate law. Shenkman was included in Top 40 Tax Accountants in 2009 and was the recipient of the New Jersey Bar Association’s Alfred C. Clapp Award in 2008. His recent books include Estate Planning for People with Chronic Illness and Disabilities (Demos); Estate and Related Planning During Economic Turmoil (AICPA) and Life Cycle Planning for the CPA Practice (AICPA), The Complete Book of Trusts (Wiley) and others.