Selling Property with Life Estate

In General

Real estate can be divided between:  a) life estate who has the right to live in the home for life; and b) a remainder interest who receives full and complete ownership when the remainderman (person with life estate) dies.  The remainderman can't do anything about the life tenant living in the house.  What happens when the property is sold?  It depends upon who is living when the property is sold.

Sale of Real Estate 

Life Tenant has Passed Away: If the life tenant/owner has passed away, upon the filing of a death certificate, there is no more "life estate" and the remainderman owns the property outright.  The remainderman receives an adjustment (step-up) in basis to the amount the property is worth on the date of the life tenant's death.  This is usually quite beneficial to the remainderman who is selling the property.  For example, if a mother buys a home for $50,000 in 1965 and the deed is such that mother retains a life estate and her son is given a remainder interest, mother passes away in 2002 when the property is worth $250,000, and in 2017 the son sells the property for $300,000.  The tax consequences to the son are that he has a capital gain of $50,000 ($300,000 less $250,000) after the step-up in basis instead of a capital gain of $200,000.

Life Tenant Is Alive:  When the property is sold before the life tenant dies, then there is no "step-up" in basis and capital gains are paid based on the original purchase price of the property with adjustments for improvements, etc. that haven't been deducted.  The resulting capital gain is divided up between the life tenant and the remainderman based on age and life expectancy.  

Exemption for Personal Residence:  The IRS will allow a homeowner who is living in the house an exemption for tax.  The exemption amount is for personal residences and is $250,00 for single and $500,000 for married owners.  The exemption is available if he owner has lived in the real property for at least 2 of the last 5 years.  However, only the life tenant can take advantage of the exemption, as he is the only person living in the home.  The remainderman is likely to owe capital gains if the property is sold during the life tenant's lifetime.