Planning for Life

Life Estate Owners: Beware Solvency of Remaindermen - Massachusetts

Posted by Harry S. Margolis on April 2, 2013

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By Harry S. Margolis

In a recent decision, Gordon v. Pappalardo (BAP No. MW 12-60, March 13, 2013), the U.S. Bankruptcy Panel for the First Circuit confirmed a Bankruptcy Court decision that holders of a remainder interest in real estate in Massachusetts do not qualify for homestead protection.

A life estate is a common form of real estate ownership often used for estate and long-term care planning purposes. Typically, parents will execute a deed reserving a life estate and granting a remainder interest to their children. As a result, both the parents and the children own an interest in the real estate, but the parents have the full right of possession during their lives. This means that only the parents have the legal right to live in the property; they would receive the income if the property were rented out; and they are responsible for its upkeep and maintenance. At the parents' death, the property passes automatically to their children, who are called the "remaindermen."

Life estates have a number of advantages. They avoid probate. They avoid estate recovery if one or both parents receives MassHealth. Unlike an irrevocable trust, they can be reversed if needed, by the children conveying back their interest to their parents. Life estates are also easier to put in place than irrevocale trusts, which is often the planning alternative.

However, this bankruptcy case demonstrates how life estates are less protective of the property than irrevocable trusts. In this case, Nicole Gordon filed held a one-quarter remainder interest in her mother's home for which she had filed a homestead declaration. Under the Massachusetts homestead statute an owner of real estate in which she resides may protect up to $500,000 of equity in her home by filing such a declaration.

The question before the Court is whether a remainder interest qualifies for this protection.  The Massachusetts homestead statute (Mass. Gen. Laws Ch. 188, sec. 1), which was amended in 2011, defines an "owner" as a "natural person who is a sole owner, joint tenant, tenant by the entirety, tenant in common, life estate holder or holder of a beneficial interest in a trust."

While the statute includes the "life estate holder," which in this case would be Ms. Gordon's mother, it does not include remaindermen such as Ms. Gordon herself. The Bankruptcy panel has little difficulty rejecting Ms. Gordon's claim.

Nevertheless, it's unclear what the practical effect of this ruling will be. Ms. Gordon's mother can certainly continue to live in the house. Theoretically, the bankruptcy trustee can force a sale of Ms. Gordon's remainder interest, but it's unlikely to find much of a market since the buyer can't really do anything with the interest during the mother's life. More likely, the bankruptcy trustee will simply take over Ms. Gordon's interest and wait to collect until the mother passes away or decides to sell the house.

In our practice, when we create life estates we include a feature that further reduces the value of the remainder interest to creditors. We would give Ms. Gordon's mother a limited testamentary power of appointment. This would permit the mother to redirect Ms. Gordon's interest to other family members, thus defeating any claim by creditors. While the Bankruptcy Court decision does not include the life estate wording to see if this feature is included, the fact that this went through two levels of federal bankruptcy court would indicate that it did not.

The moral of this story: In comparing estate planning techniques, such as life estates and irrevocable trusts, it is important to consider all of the circumstances and all of the pros and cons of each approach -- as best one can.  Of course, parents don't always know the financial circumstances of their children.

Topics: long-term care planning, asset protection, Estate Planning

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