Transfer of Residence or other Real Estate With Reserved Life Estate and Limited Power of Appointment

One estate planning technique involves the transfer of your residence or other real estate to children with the retention of (i) life use of the transferred property until the death of the surviving spouse, and (ii) a limited power of appointment exercisable by deed during lifetime or by Will at death. By retaining a life estate, you keep exclusive possession of the property during your lifetime. At the death of the survivor of the two of you, the property automatically belongs to the children. By retaining the limited power of appointment, you can at any time during your lifetime sign a new deed changing the ultimate owners of the property, provided that you cannot give the property back to yourself. The limited power of appointment also can be exercised in your Will.

Why do this type of transfer? One primary benefit is to protect the transferred property from long term care costs that you may incur, such as nursing home costs. As long as neither of you applied for Medicaid within a certain period of time from the date of the transfer, the property will not have to be sold and exhausted to pay or reimburse the county for long term care costs. Note that there are also ways that we can protect the property if you were to enter a nursing home within the specified period of time following the transfer.

There are income tax consequences to this type of transfer. By retaining life use of the property until your death, the property will obtain a “stepped up basis,” assuming the property has appreciated in value. Under current law, the basis in the property for income tax purposes is equal the fair market value at the time of death. On the other hand, if you were to sell the property during your lifetime, capital gains tax will be generated. There is a difference between the tax consequences of the sale of your principal residence versus other real estate. If you were to sell your principal residence without having made the transfer as proposed, there would be no capital gains tax on the sale of a principal residence, as it qualifies for an exclusion. On the other hand, by making the transfer, you will avoid tax on your share of the proceeds from the sale of the residence (which is determined based on the value of your life estate) but your children will pay capital gains tax on their share of the proceeds. The split of the gains tax payable by your children and by you depends on your age at the time of the sale.

With respect to the sale of a cottage or other real estate, if you sell the property prior to death, you will pay capital gains tax on the gain in proportion to your ownership at the time. The only way to avoid the capital gains tax is to retain the property until the death of the survivor of you.