Tom Kelly: Living trust can be a flexible alternative

In a recent column, we explored the use of a life estate and the complexities of selling a home when both the life tenant and remaindermen have real interests in the home.

A life estate is an agreement under which an individual’s interest in property is limited to that individual’s life. The property then passes to other recipients at the individual’s death.

In our example, a man died and gave his second wife a life estate in a home with a small apple orchard on a hillside above a lake. Upon the death of the woman, the property would pass to his three children.

When the woman, 80, considered the possibility of leaving the life estate, entering an assisted-living facility and financing that transition with her portion of the property, the three out-of-state children unexpectedly faced a surprising set of questions (plus time and research not budgeted) about the property where they were raised:

Do we really want to sell the place? Would any of us really use it in the future? What are the chances for future appreciation? If we agree on a price, what would be the shares? Which one of us would be available to grab a plane flight out there?

While the Internal Revenue Service has actuarial charts that assign approximate values for life estates, attorneys say trying to determine the exact actual value is a science unto itself and depends upon many factors, including how the property was maintained or improved.

Some individuals and attorneys use life estates (and living trusts) to avoid probate.

For example, in a life estate, a surviving spouse (Mom) could deed the house to the kids, yet reserve a life estate (exclusive right to use) for herself. This would create a life estate for Mom and remainder interests for her children. When she dies, the children would only need to file her death certificate in the land records to establish their title. Probate would not normally be required to deal with the property.

(Probate is a court-supervised process that winds up financial affairs. It can be expensive and time-consuming. It usually requires the assistance of an attorney. The executor must wait until all creditors have had a chance to submit claims and can delay the distribution of your assets to your heirs.)

The possible sale aspect of a life estate is one reason why some attorneys prefer to use a living trust to accomplish the same goals. The living trust arrangement, however, is more complex and more costly to establish; the life estate has the advantage of being very simple and inexpensive.

“Using a living trust instead of a life estate allows you to really tailor the arrangement and provide some detailed instructions regarding the holding of the property,” said Bob Pittman, an attorney specializing in estate planning. “For instance, in a living trust, you could call for an inspection of the property from time to time and you could have the trustee of the trust make sure that the taxes and insurance are paid in a timely fashion. Or, perhaps end the trust if the person moves out.”

A living trust is a legal entity that is created during a person’s lifetime to hold title to assets. Because the individual retains full control over the trust – including the right to revoke the trust and “undo” the transfers of any asset – living trusts are commonly known as revocable trusts.

They are called “living” trusts because they are created and used throughout a person’s life. A testamentary trust is usually part of a will and activated when an individual dies.

To set up a living trust, Pittman said, you must first enter into a trust agreement. The agreement is between yourself as the one who set up the trust (called a settlor or grantor) and the person who is responsible for managing the assets (called a trustee). You become the person (or one of the people) who benefits from the assets (called a beneficiary). This strategy creates a separate entity to transfer your property to without sacrificing control.

According to Pittman, since all of the benefits of a life estate can be achieved through a living trust without these drawbacks, many estate planning attorneys use life estates only in limited circumstances.