‘Life Estates’ do not work. Life estates in Wills are bad for tax. A ‘Right to reside’ is no better.
A Life Estate (including under a Will) is an asset with two owners:
- Life Tenant – this person has the exclusive right to live and make a profit out of the property until he or she dies.
- right to possess and enjoy the asset and its income until death
- all rights over the asset – but not the right to pass the estate to heirs
- Remainderperson – these people are patiently waiting for the Life Tenant to die. The Remainderperson has no right to be on the property until the Life Tenant dies.
- once the life tenant dies, ownership of the asset goes to the ‘remainderperson’
- the remainderperson takes the asset when the Life Estate ends
- remainderperson’s interest is an asset:
- you can sell it; and
- you can leave it in your Will
- a Remainderperson is also known as:
- ‘estate in remainder; or
- ‘remainderman’ (sexist terms are not tolerated at Legal Consolidated, we do not use that outdated expression)
How to create a Life Tenancy and Estate in Remainder
- You own a property as a sole proprietor. (It could be any asset, such as a car. But it is usually real estate. And often that real estate is a family home.) The property title deed reads:
- You – sole proprietor
- Like a chocolate bar, you break it in half. You give some of the property to the ‘life tenant’. You give the other bit to the ‘remainder person’:
- The life tenant gets the exclusive right to possess and occupy the property until the life tenant dies.
- You give another person the right to the property. But this is only after the life tenant dies. This person or persons is called the remainderperson. The reminderperson has no right to be on the property until the Life Tenant dies.
- On the title deed:
- Life Tenant – Joanne the second ‘ditzy’ wife
- Remainderperson – Fred and Mavis the aged husband’s children from his first marriage
- When the life tenant dies the:
- life tenancy is ‘extinguished’
- life tenancy disappears as if it never existed
- ‘remainderperson’ gets the property as the sole owner. The title deed now states:
- Owners: Fred and Mavis as sole proprietors
Example of a Life Tenancy
- Old husband Nicholas loves his young wife Delphine. But, being a woman, it is best that she does not own assets in her name.
- Nicholas does not want their family home to go to Delphine when he dies. But he does want her to live in the home until her death.
- Nicholas and Delphine have two beautiful children together: Damon and Helena.
- Nicholas and his wife Delphine both want all assets, including the home, to go to their two children after both of them are dead.
- As you would expect, the family home is solely in old husband Nicholas’s name.
- Husband Nicholas puts this Specific Gift in his Will:
- Asset: 17 Camilla Street, Windella, NSW 2320 (home)
- Life Tenant: his wife Delphine
- Remainderpersons: their children Damon and Helena
- Husband Nicholas dies
- As per the terms of Nicholas’s Will, the home is transferred. The title deeds records:
- Wife Delphine as Life Tenant
- Children Damon and Helena at Remainderpersons
- Surviving wife, Delphine, tries to sell her life tenancy
- Wife Delphine speaks to a real estate agent about selling her Life Tenancy interest in the home. A Life Tenancy is sellable. The potential purchaser could buy her Life Tenancy and live in the home until Delphine dies. But there is a risk for the potential purchaser. Delphine is young. But if she gets knocked over by a bus the day after she sells the Life Tenancy then the potential purchaser paid money to only live in the home for one day!
- Even though the home is worth about $2m, the real estate agent suggests that her Life Tenancy is only worth about $285k. Delphine decides not to try and sell her Life Tenancy.
- After the death of her husband, Delphine moves to Greece. She rents out the home and keeps the rent. Life Tenants are allowed to do this.
- The children, Damon and Helena, try and sell their Remainderperson interest
- The children, Damon and Helena, also approach a real estate agent to sell their Remianderperons’ interest. Remainderpersons are legally able to sell their interest in the property. The interest of a remainderperson is transferred without disturbing the interest of the life tenant. But the real estate agent states that there is risk for any potential purchaser.
- This is because the Remainderperson gets no access to the home (or rent) until their mother, Delphine (as Life Tenant) dies.
- The potential purchaser hands over money now to buy the Remainderpersons’ interest. But Mum may not die until she is 110 years old.
- The real estate agent states that this is not a common transaction. He has never done this before.
- He estimates the value of the home at about $2m.
- But the Remainderperson’s interest, especially given ‘your mother’s young age’ is $480k. (That would only give each child $240k each).
- The real estate agent muses that mum Delphine and the two children could get together to sell the ‘whole lot’. Then they would get the full $2m between them. The children decline to raise that issue with Mum.
- The son, Damon goes Bankrupt
- Damon, the son, enters into a bad business deal. He goes bankrupt.
- There was no bankruptcy trust in his Dad’s Will. (Silly dead Nicholashe should have built a 3-Generation Testamentary Trust Will.)
- Mr Trustee-in-Bankruptcy gets all of Damon’s assets.
- An interest as a Remainderperson is an asset.
- Mr Trustee-in-Bankruptcy transfers the son’s interest in the home to himself.
- Mr Trustee-in-Bankruptcy is registered on the title as holding a half interest as Remainderperson in the home.
- This is of no concern to Mum or her daughter Helena.
- Mum’s Life Tenancy is unaffected. Daughter Helena’s half interest as Remainderperson remains the same.
- The Title Deed now states:
- Delphine (Mum) as Life Tenant.
- Mr Trustee-in-Bankruptcy and Helena (daughter) as Remainderpersons.
- Mr Trustee-in-Bankruptcy has never seen a Life Tenancy before. They are rare. Mr Trustee-in-Bankruptcy speaks with his lawyer: “Can’t we force the Mother and Daughter to sell”:
- His lawyer states that the Mother and Daughter cannot be forced to do anything.
- Angry Mr Trustee-in-Bankruptcy sells his half interest in the Remainderperson position for a ‘miserable’ $80k.
- The purchaser of that interest is the mother, Delphine. This is through a Bare Trust Deed so that Mr Trustee-in-Bankruptcy had no idea who the beneficial owner actually was. This is legal.
- Wife Delphine is a lot smarter than her husband thought!
- The Title Deed to the home now looks like this:
- Delphine (mum) as Life Tenant.
- Delphine (mum) and Helena (daughter) as Remainderpersons.
- Daughter Helena gets divorced
- Helena, the daughter, suffers a divorce.
- Helena keeps her superannuation. But the family court requires her to transfer all other assets to her ex-husband.
- Silly old Dad, Nicholas, forgot to put a Divorce Protection Trust in his Will. So his daughter Helena’s Remainderperson interest is lost to Helena’s ex-husband.
- The ex-husband gets Helena’s half interest in the Remainderperson.
- The Title Deeds to the home now states
- Delphine – Life Tenant.
- Delphine and Helena’s Ex-Husband – Remainderpersons.
- The ex-husband is furious with this ‘useless’ half Remainderperson interest. What can he do with it? He has to wait until his ex-mother-in-law dies. A happy thought. But ‘it could take decades’.
- The ex-husband values his half interest in the Remainderperson at about $80k. But after 3 months on the market, there are no offers.
- Eventually, there is an offer of $30k from a stranger. The ex-husband takes the money in disgust.
- Yes, you guessed it. Mum has done another Bare Trust. This hides her identity as the potential purchaser.
- The Title Deed to the home now states:
- Delphine as Life Tenant.
- Delphine as Remainderpersons.
- What happens when the life tenant gets the estate in remainder? (Or, what happens when the remainder person gets the life estate?) The life tenancy and the remainder person merge. You end up with just the sole proprietor. The proprietor can update the title deeds. This shows the proprietor as the sole owner: sole proprietor. The life estate and estate-in-remainder are removed. The Title Deed now states:
- Delphine as sole proprietor.
- Yes. Delphine now has a 100% interest in the whole home. It is worth $2m. She sells it for $2m. Good on your Delphine!
Life estates are created while living or at death:
- during your lifetime; or
- in your Will – in Australia, most Life Estates are created in Wills
How does an Australian ‘life estate’ end?
- A Life Estate ends automatically. This is when the life tenant dies.
- Alternatively, if the life tenant and remainderperson agree, they can either sell the asset to a third party or to each other.
Life Estates in an Australian Will
Life estates in a Will are silly and old-fashioned. You should instead leave everything as a percentage. If you want to benefit one particular person then increase their percentage. Therefore, your Residuary Beneficiaries work out what they want to do with your estate. Life estates are just a prison sentence. Life estates are commonly put in place by people that want to rule from the grave. That is a dangerous practice.
1. Stay-at-home child gets a life estate
Young Jonny looked after his ageing mum. His siblings selfishly got married, had children and lived a life. So Jonny gets a special reward. After Mum’s death, she allows Jonny to live in the family home until he dies.
Sweet as that all sounds, that is a mess and a recipe for disaster:
- Before death, Mum suffers a stroke. She is moved into a nursing home. Mum is of unsound mind and the government/children sell the family home. It now attracts Capital Gains Tax and Land Tax. Poor Jonny misses out.
- Or, at Mum’s death, Jonny is now stuck in the house. Jonny wants to see the world and get a life – but he has no money. He just has an old house to wander around in. Perhaps, Jonny wants to get a smaller newer apartment. He can’t. He is trapped in a big ageing house that no one has any interest in looking after.
Instead, Mum should increase the percentage that Jonny gets from her estate. For example, Jonny gets 50% of the estate and his brother and sister get 25% each. Jonny is free to use his 50% of Mum’s estate as he sees fit. He is not tied down.
2. Hot toy boy gets a life estate
82-year-old Mavis finds a 48-year-old toyboy at her Bridge Club. He is not bright. He is not wealthy. But he is a lot of fun and as handsome as sin. Mavis, in her Will, gives a life estate to this young fellow. Maybe they got married, maybe they just lived together. It makes no difference.
Mavis dies. The toy boy is now stuck in a big house. He cannot sell it. He cannot maintain it. And then he suffers a stroke and moves into a cheap retirement home because he has no money. The house is left derelict.
Instead, Mavis should have left a percentage of her estate to the toy boy. He is then free to use the money to enjoy his life.
Do you still want a life estate or right to reside in your Will?
Not convinced? Start building a 3-Generation Testamentary Trust Will on our website. For free see the wording to put in your Will for:
Right to Reside v Life Estate
A ‘right to reside’ is different from a ‘life tenancy’. A Right to Reside is delicate. A life tenant has the right to move out of the home and rent it out. But if a person holding a Right to Reside vacates the home then the Right to Reside is lost.
Another name for a ‘right to reside’ is ‘right to occupy’.
‘Right to reside’ cannot be sold
As you can see above, a Life Tenancy can be sold. But a Right to Reside cannot be sold. The:
- toy boy
- stay-at-home child
- hot new 2nd wife
- other unlucky people
all lose the right of possession when they stop living in the home. In contrast, the owner of the life estate can rent out the property. The owner of the life estate can even sell the life estate.
A Right to Reside is also known as a Right of Residence.
A right to reside is when you give your loved one (beneficiary) the right to live in your property. This is often a specific gift in our Will. Yes, this is sounding very much like a ‘life tenancy’. But they are different.
A life estate is a right to possession of the property for life. A life estate is robust. A life tenancy can be sold.
Right to reside is lost when you move out of the property
In contrast, the right to reside can also be for the life of the beneficiary. Or it can be for a limited time. For example, 24 months from the date of your death. It can also be until a certain event happens, for example, the beneficiary stops living in the property.
Both the ‘life tenancy’ and ‘right to reside’ have responsibilities:
- maintaining the property
- paying property expenses
The life tenancy has the right to any income from the asset. Sadly, a right-to-reside beneficiary does not have a right to any income from the property. Further, the right to reside beneficiary must stay in the property. Once they stop living in the property their right is relinquished.
When the right to reside beneficiary moves out or dies the remainderperson takes the property. The remainderperson can sell the property or do with it as they please.
Life estates are registered on the title deeds. Right to reside is just a caveat
In Australia, you cannot register ‘trusts’ on the front page of the properties’ title deed. But a ‘life tenancy’ is not a trust. The life tenancy interest is registered on the front page of the title deed. The life tenancy interest is registered as a ‘proprietor’ of the property.
In contrast, the weaker ‘right to reside’ is registered under a caveat on the back page of the title deeds.
Adverse taxation of life estates
Life estates are riddled with tax uncertainty. There are two conflicting views on what occurs when a life interest is granted:
- Did the grant create a new asset?
- Or is the grant of such an estate a part disposal of an existing asset?
See the article S Barkoczy and P Cussen, Capital Gains Tax and the Grant of Life and Remainder Interests under Wills: the Debate Between the Creation and Part Disposal Views (1993) 22 AT Rev 209.
ATO’s position on life estates: PS LA 2003/12
The ATO’s PS LA 2003/12 is relevant to the ending of a life tenancy. This is if the trustee has the power to distribute assets in a testamentary trust to end the life tenant’s interest. What happens when the life tenant dies and the asset goes to the remainderperson? PS LA 2003/12 states that the remainderperson gets the CGT section 128-15(3) exemption.
ATO TR 2006/14 – transferring a life estate
In contrast, what happens if the life tenant gives up the life tenancy while still alive? What are the tax consequences of terminating prematurely a life interest? TR 2006/14?
The trustee is treated as the relevant asset ‘owner’. The trustee’s cost base is the cost base of the asset in the deceased’s hands. Or, if it was a pre-CGT asset, its market value at the date of death (see paragraph 18).
What about the beneficiaries? They also each have separate CGT assets. These are their ‘trust interests – the equitable life and remainder interests’ (see paragraphs 24 and 188). The beneficiaries’ interests in the testamentary trust have a cost base equal to their market value (see paragraphs 26 and 144).
Value life estate and remainderperson’s interests to find the cost bases?
Are the assets that originally formed part of the deceased’s estate exempt from CGT? Yes. But only if they pass from the executor to the remainderperson. This is under the terms of the Will (paragraph 45). This just repeats PS LA 2003/12.
Thankfully, the ruling states that the life tenant does not make a capital gain. This is when they die. See paragraph 43 and 44. I would have thought this obvious.
Tax when a life tenant surrenders their life estate interest
Life interests imply until the life tenant finally dies. But the life tenant may wish to surrender the life interest earlier. This may be for free or for a price. Either way, this is a ‘disposal’ under the CGT regime.
This is a different situation of getting something in a Will. Gifts in Will carry CGT relief, especially if your Will contains a 3-Generation Testamentary Trust. Consider:
- whether the property is sold by the trustee or is transferred in specie to the remainder beneficiaries; and
- whether there are multiple remainder beneficiaries or
whether there is a sole remainder beneficiary
If the life tenant surrenders their interest, CGT event A1 happens. This is to the life tenant (see paragraph 66). But if no money changes hands or the surrender is not at arm’s length, section 116-30
ITAA97 treats the person surrendering the interest as receiving the market value of the interest they surrender (see paragraph 68).
But the distribution to the remainderperson involves assets that originally belonged to the deceased. And the remainderperson getting the asset is under the terms of the Will. Therefore, it should be free from CGT under s 128-15(3). But the ATO does not say that the ‘early’ inheritance is in accordance with the Will. We are in doubt.
For tax purposes, a life estate is three assets
There are three separate assets for CGT purposes:
- the life interest owned by the life tenant
- the deceased’s property that is subject to the life interest
and owned by the trustee (“deceased’s property”);
- the remainder interest owned by the remainder
Remainderpersons don’t get the ‘principal place of residence exemption’
What if the ATO successfully argued that an early release by the life tenant was not in the terms of the Will? Then the executor realises a capital gain under CGT event E5 or E7. Both the ATO and I agree that this approach applies in dealings between the life tenant and remainderperson. This is where the life tenant gets payment for relinquishing the share or part of the proceeds of the sale. But I would think the ATO is wrong to invoke CGT if there was merely an early surrender by the life tenant.
Other issues are calculating the cost base and the loss of the principal place of residence exemption.
For example, your mum and dad die. Your alcoholic brother gets a life estate. You get the remainderperson interest. Your brother is young. The property is worth $1m. The actuary gives your alcoholic brother a cost base of $700k. Your cost base is $300k. A year later your brother dies of alcoholic poisoning. You are deemed to have acquired the $1m property for $300k. There is no principal place of residence. You sell the property for $1m. You have made a $700k capital gain to put into your tax return.
Life estates are bad because they don’t work and suffer harsh tax treatment. Life estates are best avoided in your Will.
But you may be able to overcome this under section 118-195 Income Tax
Assessment Act 1997 (Cth) .
Life Estates and Right to occupy – 4 additional problems
When drafting and administering life interest trusts consider:
- who pays the expenses and outgoings?
- the risk of family provision claims – a life tenant may still challenge your Will to seek the removal of the life estate
- providing for substitute accommodation – this is just a ghastly mess. Your children want their step-parent to live in a tent on a big block of land (to maximise capital gain). And the stepparent wants to live in a snazzy apartment – with little capital appreciation
- the choice of trustee of a life interest trust – who are the executors?
Life Tenant challenging your Will
A family provision claim is where your surviving spouse feels that they have not been adequately provided for in your Will. An order from the court for provision to be made by way of a portable life interest is called a “Crisp order”.
A Crisp order gets its name from the decision of Holland J in Crisp v Burns Philp Trustee Co Ltd.
It is often made by judges in circumstances whereby your surviving spouse wishes to ensure that they are given sufficient provision without unfairly prejudicing other beneficiaries who may have competing claims (such as the children of your first marriage).
Ipp JA in Milillo v Konnecke  NSWCA stated:
“… a Crisp order may entitle a plaintiff, from time to time, to require the executor of a will to sell a home devised by the will, or otherwise owned by the estate, and to use the proceeds for purposes that may include purchasing another home for the plaintiff’s use and occupation, or providing accommodation for the plaintiff in a retirement village or similar institution, or in like accommodation providing hospitalisation and nursing care. The flexibility provided by such an order underlies the notion that a Crisp order confers a ‘portable life interest’.”
Life Estates and Granny Flats
Another Specific Gift in a Will is a life estate of a granny flat. This is where:
- the Will maker gives a right to reside or a life estate in a part of a property to a beneficiary
- that part of the property is where the granny flat is situated
- when the beneficiary dies the right to reside or life estate interests dies with them.
The granny flat life estate is not necessarily for your last to die aged parent.
It is also for your:
- first divorced wife, where the property settlement went horribly wrong; or
- 30-year-old child not ready to leave home.
A granny flat life estate is confusing and messy. It is a bountiful gift to litigation lawyers. Also, the granny flat right to occupy or life estate under a Will is not tax-effective.
Tax implications of a granny flat life estate
Since 1988 these are the tax issues of granny flat life estates faced by our law firm:
- Any payment of money for the right to occupy a granny flat is a capital gains tax (CGT) event. This is event: CGT Event D1.
- CGT Event D1 is triggered even if the granny flat is created from part of the family home.
- The CGT is payable on the consideration paid for the grant of the granny flat right to occupy. It does not matter if the agreement was verbal or in writing.
- What if the consideration paid is less than the market value? The market value substitution rule applies. The government values the transfer and (stamp) duty and CGT applies.
- There is a risk that the owner of the rest of the property loses, at least in part, the CGT main residence exemption.
1. Bankruptcy and Life Estates
A ‘life interest’ is an asset. It potentially makes income. What happens when the life tenant goes bankrupt? The trustee-in-bankruptcy kicks you out. He takes possession of the asset. He:
- leases out your property; and
- can sell the ‘asset’. (Sale of the Life Estate, of course, does not effect the rights of the patient Remainderpersons)
2. Bankruptcy and Right to Occupy
However, what if you only have instead a ‘right to occupy’? A ‘right to occupy’ is an asset. And if you are bankrupt assets must be put under the control of the trustee-in-bankruptcy. This is for the benefit of your creditors.
But, you cannot be forced out of your home. Well, to put it another way, if you were forced out of your home then your ‘right to occupy’ is extinguished. The asset is destroyed. This is by you failed to live in the property. This is a condition and delicate nature of a ‘right to occupy’.
But, what if the trustee-in-bankruptcy allows you to remain in the property under the ‘right to reside’. And then deems you to be receiving value or income. This is because you live in the property under a ‘right to occupy’?
The Bankruptcy Act 1966 (Cth) defines the concept of ‘income’ widely. The free use of a home may be considered ‘income’.
Ruling from the grave – life estate
Q: My partner died suddenly. He left me a ‘life interest’ in our $2m home that we shared together. Two conditions:
- I maintain the property and pay the rates, which is fine; and
- I forfeit the life estate if I remarry!
Should I negotiate to buy the property outright from his three adult children? To do this it would cost me most of my super plus a large sum of his (which he also left me). What are your thoughts regarding life interests in a home? What are the pitfalls I should be aware of? Joanne.
A: A Life Estate has two owners:
Life Tenant – Joanne you have the exclusive right to live and make a profit out of the home until you die. You can even sell your life interest. But it is not worth much. Who wants to buy something that ceases to exist when you die? I hope not, but you could die tomorrow.
Remainderperson – the 3 adult children are patiently waiting for you, the Life Tenant, to die. They have no right to be on your property until you die. They can also sell their interest, now. But it is not worth much. Because, Lesley, you may live to 120 years of age! And I hope you do.
From a Capital Gains Tax point of view, it is a disaster for his three children. The children usually end up with a bigger Capital Gains Tax once you are dead and they sell the property. The children, under complex tax laws, may be deemed to have acquired the property for say $200,000s. If they sell it for say $2m they are up for $180,000 CGT tax.
The condition that you lose your Life Estate if you remarry is void. It does not operate. This is because it is contrary to the rule of Public Policy. A Will maker cannot put conditions into the Will such as the ‘gift is lost if you challenge the Will’ or ‘you lose the gift if you marry a Methodist’.
You may wish to challenge the Will and ask that you get the home outright. That ‘no marry’ clause will not make the judge happy. And increases your chance of winning. It also smacks of a homemade Will or post office Will. And they are also easier to challenge.
Or, given that the home is worth say $2m, you may wish to, together with the 3 children, sell the home and split the money $1m to you. And $1m between them.
- What happens to super if you go bankrupt?
- How to protect yourself from bankruptcy
- Bankruptcy Trusts in Wills
- Who can challenge your Will?
- CGT on dead wife’s wedding ring
- Even a pre-1985 family home can be subject to CGT
- Two years to sell your dead parent’s family home exemption – now you can get 3 year