Life Estate Insurance Blunder

Real Property

Forgetting to simply add one name to a homeowner’s insurance policy could compromise an heir’s property inheritance. For individuals who take advantage of the added protection, reduced taxes, and ability to avoid probate that a life estate offers when holding title to property, one mistake with insurance may create more problems than their careful planning had intended to prevent.

In North Carolina and other states, owners of real property may transfer ownership of the property to Remainder Owners (typically children), while at the same time reserving lifetime rights to remain living in the home (becoming Life Tenants, holding a Life Estate). All parties have interests in and co-own the property. In some cases, Life Tenants may neglect to add Remainder Owners to the insurance policy. Should the property suffer a fire and become damaged or totally lost as a result, and the Life Tenants die in the same accident, the recovered expenses from the insurance company may be paid to the Life Tenants’ estate. This means it may be distributed to other surviving heirs, which may not be the same persons as the Remainder Owners. The Remainder Owners may not receive the full recovery from the insurance company and may have to pay for the cost of repairs themselves or sell the property under market value. With proper planning and to avoid this complication, the insurance policy should be immediately updated when the life estate is created to include both the Life Tenants and named Remainder Owners.
Although transfers with retained life estates avoid probate by automatically transferring property ownership to Remainder Owners upon the death of the last surviving Life Tenant—and they offer other protections for Life Tenants who may need to preserve eligibility for Medicaid—these transfers do have a couple of potential disadvantages.
Disadvantages of Life Estate Transfers
  • Tax liabilities. A life estate does eliminate or at least minimize capital gains taxes for Remainder Owners when title is fully transferred upon the last surviving Life Tenant’s death, however should the property need to be sold before all Life Tenants have passed away, the Life Tenants and Remainder Owners in particular may face capital gains tax liabilities.
  • Property sale complex. Should Life Tenants decide they want to sell the house, they will need the consent and signatures of Remainder Owners named in the life estate. However, any individual named may transfer their interest to another party at their own discretion without the approval of or notification to other co-owners. This means a Remainder Owner may have passed their ownership to a spouse or other individual and conflicts may develop over the sale of the home.
With these disadvantages in mind, a life estate may not be the right estate planning tool for every family in North Carolina, although the use of “Enhanced” Life Estate (Ladybird) deed, popular in many states, can avoid these problems. For any property held with a life estate deed, it remains critical to add Remainder Owners to the insurance. Review other ways to hold title in North Carolina and important estate planning matters to consider if you purchased a second home or have properties in multiple states.
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