What a ‘life estate’ means for your home

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Q. A relative married a guy who has a life estate on his parents’ house and they have been living there since maybe the mid 80s. What would the tax consequences be for them now that they are thinking of moving? They have four children but they’re scattered so it’s time for them to dump the cash sieve and downsize.
— Trying to figure

A. Let’s talk about how this estate planning strategy works.

A life estate gives the holder the legal right to possession of real estate.

The owner of the remainder interest also has an ownership interest in the same property, but it’s the life estate holder who has the right to possession, said Yale Hauptman, an estate planning attorney with Hauptman and Hauptman in Livingston.

Hauptman said the life estate holder can live in the property or rent it and keep the proceeds.

“The life estate holder is responsible for the maintenance and expenses of the property,” he said. “At the life estate owner’s death, the life estate expires. It cannot be transferred to someone else.”

If you are a life estate holder and living in the home and the home is sold, both you and the remainder interest owner must agree to sell for the buyer to take 100 percent ownership and possession of the property, Hauptman said.

“The IRS has established life estate and remainder interest tables to calculate the value of each interest,” he said. “The older the life estate holder, the less ownership interest he/she has and the more ownership interest the remainder interest holder has.”

Hauptman said if the home is sold, the proceeds must be split between the life estate and remainder interest owners based on the IRS tables.

If the home value has appreciated considerably, there may be capital gains tax to pay.

“If the life estate owner has lived in the home in two of the last five years before the sale, he/she can exempt up to $250,000 of capital gains from tax under the primary residence exemption,” he said. “The remainder interest owner cannot use the same exemption, however, since he/she is not entitled to possession and thus cannot claim it as a personal residence.”

If the sale happens, be sure to work closely with your tax preparer and an estate planning attorney to make sure you get it right.

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This post was first published in July 2017.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.