Life Use in Real Estate

A common strategy in the game of “save my assets from the nursing home” is to take them out of the name of the person we fear will get sick. Ideally this person gets the assets out of their name at least five years before they or their spouse needs long-term care. That relates to the Medicaid “look back,” which is really a fancy way of saying that once you apply for Medicaid to pay for care the State gets to review five years’ worth of all your bank statements. While the timing of the gift matters, with some exceptions, what I want to talk about is HOW you give the house away, what a life use interest means, and how it can benefit you and your family.

The process begins with a Quit Claim Deed. This is the type of deed typically used to transfer ownership of a house or other real estate without actually selling it. Often the house is given to a trust, or to the children. There are two options for what the deed says when you make a gift like this. It either is a full gift, which means there is a new owner that has 100% of the home, or it is a partial give where you retain a “life use” in the property. This choice applies to transfers to a trust and to a person. Either way, the pros and cons of the two choices have to do with risk tolerance, capital gains taxes, future bill pay for the property, and control.

If you transfer the property to a trust, then you likely keep a good deal of control over the property simply because it’s your trust, whether it is revocable or irrevocable. So, keeping a life use may not matter as much to you in a trust, but if you do not keep life use in an irrevocable trust then you will need to pay rent to the trust. An irrevocable trust cannot give you anything back, including a free place to live.

If you transfer the property to your kids but keep a life use then you still own the controlling part of the house, which means you are responsible for the taxes, homeowners’ insurance and major upkeep and they cannot sell it out from under you. This also means that when you pass away the family will get a full step up in tax basis, which means they will inherit the home at its current value without paying capital gains tax. This can mean a great deal of saving for them if the house is sold after you pass.

If the home is sold during your lifetime your co-owner will get paid out their percentage and you will receive your calculated life use which is based on your age, sex, and sale price of the house. In most trusts you can keep this exclusion to paying capital gains tax even if there is no life use. But when you co-own the property with someone who doesn’t live there the life use is critical. For example: You have a life use, and the kids own the rest of the house. You bought it for $100,000 years ago but will sell it for $350,000. There have been $250,000 worth of gains since the purchase. Since you have a life use, your $250,000 exclusion means we can act as if there was no gain. Without that life use, the kids would sell the property and have to pay 15% tax on the $250,000 of gains. That’s $37,500 wasted!

Life use is a way to keep your hand on the wheel when it comes to real estate you want to protect. It’s also a way to help the next generation avoid unnecessary taxes. It does come with risk of course. If you are permanently in a nursing home when the house sells, you get your share. In the wrong situation that part will just all go to the nursing home. But it’s a very useful tool overall, especially if you don’t want to use a trust in your planning.

Attorney Halley C. Allaire is principal in the law firm of Allaire Elder Law, a member of the National Academy of Elder Law Attorneys, Inc., with an office at 271 Farmington Avenue, Bristol, (860) 259-1500, or on the web at www.allaireelderlaw.com. If you have a question, send a note to Attorney Halley C. Allaire and your question may be discussed in a future column.