Life Interests in Property
Dealing with a life interest in property isn’t something that is encountered very often, however there are some important points, should you come across one.
It is common that real property held in a deceased estate is left to the beneficiaries of the deceased estate. The beneficiaries may have the property transferred into their names or the property may be sold with the sale proceeds distributed to the beneficiaries.
It is the case that in a bankrupt estate a person may be left a life interest in real property. In determining whether a life interest in a property has been granted, as opposed to a right to reside, the Last Will and Testament (“Will”) of the deceased person must be considered.
When describing the interest in a property, should the Will use words like “to permit to reside”, this indicates a right to reside has been granted. Should the Will use words like “use and occupy” or “occupy” alone, this indicates a life interest in a property has been granted.
Right to Reside
A right to reside in a property is an equitable right to occupy the property in accordance with the conditions set out in the Will. A common requirement included in many Wills is that the person granted the right to reside must maintain and keep the property in a reasonable state of repair, if this requirement is not satisfied the right to reside could be contested. Granting a right to reside is often employed to allow the spouse of a deceased to continue to reside at a property without triggering a capital gains tax event.
A right to reside differs from a life interest as greater limitations for the use of the property exist. Generally speaking a right to reside will allow just that, the person granted the right to reside may live at the property however is not able to sell, rent or utilise the property for any other gain. A right to reside will cease once the person granted that right no longer occupies the property. This may occur due to the person electing to forfeit their right to reside or in the event the person granted the right to reside passes away.
A life interest in a property provides a person a right to occupy the property as well as the ability to sell, rent or use the property for their benefit. A life interest differs from a right to reside as the interest in the property is not forfeited should the person vacate the property.
It is worth noting a life interest may have limitations placed on it pursuant to the conditions of the deceased’s Will. Examples of these limitations include the life interest ending should a person remarry or the life interest may only be granted for a specific number of years. It is possible that a life interest in a property will continue to vest in a person for the extent of their life should the limiting conditions of the Will not come into effect.
A person holding a life interest in a property may wish to sell their interest rather than occupy or utilise the property throughout their lifetime. Unfortunately, the market to sell a life interest in a property is limited due to the interest in the property returning to the deceased estate after the life interest ends.
Usually, the most viable option for selling a life interest in property is to sell it to the remainderman. The remainderman is the person/s entitled to the interest in the property after the life interest ends.
There are a number of methods that can be used to value a life interest in a property to ensure a sale is for a fair value. The most common method for valuing a life interest in a property is a discounted cash flow method.
This involves assessing the net cash flow that can be generated from the property, often rental income less maintenance and management costs, and discounting these cash flows to their present value. Adjustments to the value of a life interest may also be applied to account for the age and health of the person holding the life interest.
Return of Property to Deceased Estate
Once the right to reside has been forfeited or a life interest ends the property will return to the deceased estate and is then distributed in accordance with the Will.
Impact of Bankruptcy
If a person is made bankrupt and they hold a right to reside in a property, given the strict limitations discussed above it may be difficult for Bankruptcy Trustees to realise that as an “asset”. However, should a person be made bankrupt and they hold a life interest in property, the life interest is likely to be realised for the benefit of the bankrupt estate.
The nature of a life interest satisfies the description of property set out by the Act and in accordance with section 58 of the Bankruptcy Act 1966 (Cth).
A life interest will vest in the Bankruptcy Trustees whether it is held by the Bankrupt at the date of bankruptcy or is after-acquired property. The vesting of the life interest in the Bankruptcy Trustees is supported by the decision Re Hannon; Ex parte Official Receiver (1945) 13 ABC 218.
Bankruptcy Trustees have a duty to creditors of the bankrupt estate to realise a life interest in property and will approach the realisation of a life interest in the same manner as an ordinary person.
The key difference for Bankruptcy Trustees dealing with life interests compared to an ordinary person is the vesting of a life interest in the Bankruptcy Trustees will be limited to a maximum period of 20 years from the date of bankruptcy pursuant to section 127(1) of the Bankruptcy Act 1966 (Cth).
The Bankrupt’s father was elderly and prior to the bankruptcy he intended to leave his son (the one who was made bankrupt) an interest in real property. Upon the bankruptcy commencing the father amended his Will to no longer leave an interest in the property to his son. The father’s intention was to avoid the property vesting in the Bankruptcy Trustees and so being realised for the benefit of creditors of the bankrupt estate.
Instead, the father left his son a life interest in the property. During the period of the bankruptcy, the father died, so leaving the Bankruptcy Trustees to consider their ability to realise the life interest in the property.
The Bankruptcy Trustees engaged an expert Valuer to obtain a valuation of the life interest in the property. This valuation was used as a tool to enter negotiations with the remainderman and the executor of the deceased estate to agree to a settlement for the return of the life interest to the deceased estate.
After agreeing to a settlement and entering into a Deed of Settlement the Bankruptcy Trustees allowed the property to be sold with a portion of the sale proceeds collected by the Bankruptcy Trustees as payment of the settlement. Realising the life interest allowed for sufficient recoveries to be made in the bankrupt estate to pay a dividend to creditors. If the Bankruptcy Trustees had not reviewed the Bankrupt’s Father’s Will and identified the life interest, it is unlikely any return would have been paid to creditors of the bankrupt estate.
Although life interests in property are not encountered on a frequent basis it is interesting to note the benefits that can be obtained including the ability to sell the life interest and the impact bankruptcy will have which may be in contrast to the intentions of the Will of the deceased.
Calculating the Value of Life Estate Land
The purpose of this commentary is to simply give an overview of the process as well as an example. It should not be followed as any sort of professional opinion as to how to calculate such interests.
The formula consists of taking the date of birth of the life tenant as at the date of the creation of the life estate, rounded off to the nearest year, then comparing the age to an actuarial table to determine the”life tenant factor”. Then multiplying that number by the market value of the life estate land in which the subject life interest is being created to calculate the value of the life interest.
That figure in turn is subtracted from the market value of the land to calculate the value of the remainder interest (The life interest plus the remainder interest must equal the total market value of the land being transferred).
How to value a life interest
You will need access to an Actuarial Life Table – CLICK HERE
Pam aged 77 is the sole registered owner of land valued at £185,000.
Pam decides to transfer this land to her son for £80,000, subject to a reservation of a life interest in it for herself.
Referring to actuarial tables, Pam’s life tenant factor is calculated as a female aged 77 so given her a life tenant factor of .38603
The value of the life interest is £185,000 x .38603 = £71,415
Therefore, the value of the remainder interest is £185,000 – £71,415, = £113,585
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