The Impact of Life Estates on Property Taxes
Author’s Note: While these articles are not meant to contain legal advice, the author acknowledges the assistance of Diane Dillon, Esq.
A life estate vests the beneficial use of property in a person for their lifetime. The person who holds the life estate is the life tenant. The life tenant may have the right to occupy a residential property and/or the right to income from property that is rented or leased to others. Unless specially restricted, a life estate can be sold, leased or mortgaged. Because beneficial use of the property accompanies a life estate, the creation, transfer or termination of a life estate is a change of ownership under Proposition 13. Under certain circumstances, that change of ownership can lead to a reassessment of the property and the establishment of a new base year value. The persons who get the property at the termination of the life estate are either the remainder holders (if other than the original grantor of the life estate) or the reversion holders if the property comes back to the person(s) who granted the life estate.
An example of a retained life estate is a husband and wife who grant their property as a gift to their children but retain the right to live in the property for their lifetimes. Because beneficial use does not transfer to the children until the death of the last life tenant, there is no change of ownership until that event occurs.
A retained life estate can have different consequences. The owners of a home and workshop occupying 1 acre of a 15-acre vineyard parcel decide that they can no longer manage the vineyard or afford to replant it. They sell the parcel to strangers and retain a life estate only in the residence and the workshop. Because the balance of the property was transferred free of a life estate, i.e. the full beneficial use of the vineyard transferred to the new buyer, this office would reassess the 14 acres of vineyard land and the vines and non-living improvements. The original owners would retain their base year value on the home and workshop, and reassessment for change of ownership of that acre and improvements would not take place until the death that terminates the life estate.
A granted life estate occurs when Mrs. Jones decides to transfer her home to her children and move to a retirement community while granting a life estate in the home to her good friend, Mrs. Smith. This grant of a life estate is a change of ownership and would subject the property to reassessment since Mrs. Smith is neither the parent nor the child of Mrs. Jones. After 5 years Mrs. Smith decides to relinquish her life estate and turn the property over to Mrs. Jones’s children. This termination of the life estate is another change of ownership. However, since the remainder interest is now going from the original grantor, Mrs. Jones, to her children, they may be able to claim a parent-to-child(ren) exclusion from reassessment for this second change of ownership. Assuming the exclusion is granted, the children would retain the base year value established at the grant of the life estate to Mrs. Smith plus inflationary adjustments as permitted under Proposition 13.
Life estates are useful in estate planning. However, granting or retaining a life estate may have gift, estate, income tax and other consequences beyond the scope of this article. Anyone considering retaining or granting a life estate should consult an attorney and financial advisor before proceeding.