12 Jul What are the restrictions for a life estate?

Q. When you use a life estate, how does it work? What are the restrictions and who pays the property taxes and other expenses for the home?
— Planning ahead

A. Life estates are used for various estate planning purposes, but the most common is where a parent transfers a home to a child and retains a life estate for themselves.

As a result of the transfer, the child owns the home but the parent has certain rights and responsibilities, said Mary Scrupski, director of estate planning with Prestige Wealth Management in Flemington and Millburn.

“The most important right retained is the exclusive right to reside in the property,” she said. “The child cannot force the parent to move out; nor does the child have any right to live there.”

Scrupski said the child may live with the parent, but the deed does not give the child the legal right to reside there.

The parent is obligated to pay the property taxes and all ordinary maintenance items associated with the property, she said.

Plus, the life tenant is responsible for repairs but not improvements.

“This can be difficult to determine but in general the life tenant must maintain the property in the same condition as when the life estate deed was signed,” Scrupski said. “If the parent moves out and the property is rented, the parent has the right to receive all of the rents.”

When the parent dies, the life estate is automatically extinguished, and the child now has all of the rights associated with the property, she said.

From an income tax point of view, when the parent dies, the property gets a “step up” in basis to the date of death value, Scrupski said.

“If it is sold after the parent dies, the capital gain or loss is calculated by deducting the date of death value from the sales price,” she said. “This is an important tax advantage if the parent has owned the home for a long time and has a low basis.”

Retaining the life estate can help the child avoid capital gains tax better than just transferring the property outright to the child, she said.

On the other hand, if the property is sold while the parent is still alive, a portion of the proceeds will be allocated to the parent and a portion will be allocated to the child.

“Only the portion allocated to the parent will be excluded from income under the tax code,” she said. “The portion allocated to the child may be subject to capital gains.”

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This story was originally published on July 12, 2019.

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.