Just a point of clarification. If the deed is set up as a life estate and you decide to sell before death, your share will be again subject to the Medicaid look-back period of 5 years and your kids’ share(s) will be subject to capital gain taxes. Been there, done that.
This is absolutely correct and a MAJOR limitation of a life estate.
Some people are tempted to transfer their home to their children while retaining a life estate. Why? This will protect your property from Medicaid after the five-year look-back while retaining your control, avoiding probate, and wiping out your capital gains upon death. WOW! That sounds great…and by the way, it is less expensive to set up than a trust.
BEWARE! LIFE ESTATES ARE TRAPS FOR THE UNWARY!
A life estate can be a good tool in the toolshed for some people, but not most. For every thousand clients I have that want to protect their home from Medicaid, I probably will do one life estate, and the rest of the time I do an irrevocable trust. Why? Because if you sell your home during your lifetime you will have big tax and Medicaid problems.
The tax problem is that the percentage of the property owned by your children (most of the value) will be subject to capital gains tax. Your children will receive no benefit from your $250,000 capital gain exclusion. You can only use your exclusion against the capital gain on your life estate portion, which will be a small percentage.
The Medicaid problem, as pointed out by my reader above, is that you will receive the value of the life estate upon the sale, which will then be vulnerable to Medicaid. If you transfer these proceeds to your children, this will incur a new five-year lookback.
Both of these problems are eliminated with an irrevocable trust.
However, if a client is willing to sign in blood that they will never sell their property during their lifetime, then we can give a life estate more serious consideration. But are you really ready to commit to NEVER selling your house? What if you were in a nursing home and the house was empty? Perhaps at that point, you may want to allow your children to sell the house. Perhaps you should keep your options open.
I hope this sparks further questions.
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