real estate

Pros and cons of creating a life estate

Steve McLindenDear Real Estate Adviser,
I'd like to buy my mom's house, and she'll gladly sell it to me, but she isn't quite ready to give it up. Is it possible for me to work out a way to buy it but still have her legally maintain control in some way? I'm afraid I'll miss out on the good interest rates if I wait for her to completely let go.
-- Dan R.

Dear Dan,
Yes. You and your mother can agree to a joint-ownership agreement called "life estate," where she keeps the right to live in and essentially control the home. When you do this, you're creating a life estate. She'd be the "life tenant" and you'd be the "remainderman." The agreement would state that you'd be the owner when she dies. You can agree to split all or part of the mortgage, property taxes and insurance any way you want, but realize she may be obliged for these if you default or die.

There are pros and cons to a life estate. Among the cautions: If you buy the home at considerably less than market value, you could run afoul of Internal Revenue Service restrictions, which could consider it a gift. Should you need to sell the place under the life estate structure, the only way to do so would be to obtain a release from her. In other words, you'd essentially have to wait for the death of your dear ol' mum before you could enjoy the full benefits of ownership.

Additionally, Medicaid administrators can now look as far as five years back and disallow asset transfers performed for the purpose of Medicaid eligibility. So if she were to need nursing home care within five years of signing that life estate deed, she might have to pay privately for the care until the penalty period ended. And if she were to pass away leaving behind uncompensated state-sponsored health care obligations, the state could come back and make a claim against your property.

So if you're going to make such an arrangement, time's a-wasting because the creation of a life estate deed triggers that Medicaid-eligibility waiting period.

One major plus for you under life estate structure is the home would be valued for tax purposes at the date of her death, not its value when your mom originally acquired it. That would help you avoid capital gains taxes when you eventually decide to sell.

Though your mom understandably wants to maintain control of the house, you should at least both explore the option of you buying the place and renting it -- or a portion of it since you would be moving in -- back to her. She'd get to withdraw her trapped equity in the place and travel or reinvest the money if she wants, and you'd get to deduct the related depreciation and operating expenses on your income tax against the rental paid to you.

There may be other options for you and your mom to handle the purchase that allows her to retain control, such as a living trust with you serving as trustee. Given that and all the other variables, it's absolutely imperative that you consult with a tax adviser, estate planner or real estate attorney to help structure the deal based on your mom's financial, retirement and emotional needs.

I do understand the time pressure, though. Interest rates have been heading north. A 30-year fixed-rate mortgage today versus the 3.31 percent record low set in November 2012 roughly translates into an extra $30 to $35 per month for every $100,000 of accrued debt. So don't tarry.

Good luck!

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