The differences and effects of a right of occupancy granted under a Will versus a life estate, are topics that our wills and estate lawyers are often asked to advise upon for clients that are Will-makers (“Testators”) or beneficiaries of an estate.
This article is intended to provide a brief insight into the differences, the benefits and potential risks when dealing with a Will, including a right of occupancy or a life estate, as provisions that are drawn improperly can have unintended and often significant consequences for the estate in question.
Definitions – what is a right to occupy and a life estate?
Both a right to occupy and a life estate may be created in real property (such as a family home) or personal property (such as shares or income producing assets). They are created for a person (“life tenant”) that enjoys possession or use of the asset (and depending on the asset and Will, its income or sale proceeds), during their lifetime and until their passing, where the benefit of the asset then reverts to the Testator’s ultimate beneficiaries (“remaindermen”).
Differences
The difference between a right to occupy and a life estate is that a right of occupancy grants occupancy rights only. These are equitable in nature and the Will is often quite restrictive in what the life tenant is entitled to do with the occupied property. In most cases, a right to occupy will commonly include conditions which require the life occupant to (inter alia):
- pay rent, outgoings (such as rates, water or other occupancy costs);
- keep the property in a reasonable state of repair;
- not leave the property vacant for long periods of time; and or
- not rent the property to anyone else or make income from it.
A failure to abide by any stated conditions can result in an automatic termination of the life estate arrangement.
A life estate 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, or even substitute another property in place of the existing or initial property. A life estate differs from a right to reside, as the interest in the property is not forfeited should the person vacate the property and may be forfeited for other reasons (such as remarriage or due to the expiry of a time condition written into the Will).
Upon the ending of the life estate, the Testator’s Will would typically provide that the property would be transferred in specie to the remaindermen or sold and the proceeds distributed to them.
Life estates can be an effective estate planning strategy for blended families, where only one party to a marriage or defacto relationship owns the family home and has done so prior to the commencement of their current relationship with either (or both) partners having children from prior marriages or relationships. It is a convenient way to apportion the benefit in land by ensuring that one beneficiary has the use of the land for the duration of the beneficiary’s life and that the capital is preserved for another (often younger) beneficiary.
A life estate is registrable on the Title of the subject property to ensure the interest is known and the property cannot be sold without the life tenant’s knowledge and consent.
Pitfalls
Notwithstanding the above, life estates are not without their pitfalls, which may include, inter alia (depending on the circumstances):
- Inflexibility – especially where the life tenant is unable to make improvements or changes that may be required due to the age of the life tenant (eg ramps, rails or other support items);
- Ongoing costs – life tenancies can be drafted in different ways, however where the Testator’s Will provides that the Estate is to pay some of the costs (eg repairs, insurance costs, property outgoings etc) this means that estate funds need to be held by the executor of the Will for a significant period of time to budget for such expenses;
- Ongoing administration – whilst the life tenant is in occupation, the executor of the Testator’s Will is required to perform their role for a long period (sometimes for many years) in ensuring that the life tenancy terms in the Will are complied with and ultimately facilitate the bequest of the asset to the remaindermen upon the life tenant’s passing;
- Remaindermen are delayed – many remaindermen are often waiting for their inheritance for a significant period of time, whilst the life tenancy is in effect and receive little to no benefit in the meantime if the property that is the subject of the life tenancy is the sole or major asset in the estate;
- A life estate is a property encumbrance that prevents or affects subsequent dealings. In Queensland, it is common practice for it to be registered on title to the property and if it is not registered, it would need to be disclosed to any bank or financier as it will affect the ability of the Testator to borrow funds against the property or use it as security. Upon the death of the Testator, the property that is subject to the life estate will remain in the name of the Executor of the estate and cannot be used by the remaindermen as security for any loans they may wish to obtain, until the life estate has been terminated and the property vests in their own names; and or
- A spouse or defacto left with the provision of a life estate in respect of the matrimonial home may feel that the rights under the life estate are restrictive – especially where they have not received anything else from the estate. As an eligible person under the Succession Act 1981 (Qld) this could result in the spouse or defacto making a family provision claim against other estate assets given to other beneficiaries (such as cash in bank accounts, shares, other specific assets, the proceeds of any life insurance proceeds and superannuation (in some circumstances).
Financial considerations – Capital Gains Tax (‘’CGT’’) and transfer (stamp) duty
CGT
Where a life tenant wishes to voluntarily end their life estate (for example, if they wish to downsize, move elsewhere for financial reasons etc) they may do so by surrendering their life estate, however, the Australian Taxation Office (“ATO”) may view as the disposal of an asset, for CGT purposes if the power to surrender is not specifically contemplated by the terms of the Will.
If the Will provides circumstances where the Executor and the life tenant can agree to end the life estate early, then CGT may potentially be avoided, as the ATO may then view the life estate as coming to an end as permitted in the Will.
Transfer duty
Life estates and estates in remainder that grant an interest in land (or its proceeds) are dutiable property under the Duties Act 2001 (Qld). Accordingly, the creation or transfer of a life estate or estate in remainder is subject to transfer duty, unless an exemption applies.
A mere right of occupancy is not dutiable. To distinguish between the two, there must be clear words showing an intention to create a life estate, such as ‘to Beneficiary A for life’ rather than simply a ‘right to reside’. The distinction relates to whether the nature of the residency right is a transferable interest in land or not, or whether it will be extinguished when the beneficiary ceases to occupy the property.
The importance of using a carefully drafted Will from an experienced estates lawyer, coupled with proper accounting, financial and taxation advice from an experienced taxation accountant for the particular circumstances cannot be overstated, as proper drafting can avoid significant taxation or transfer duty consequences for the estate, the life tenant, the remaindermen or even the beneficiaries of other estate assets or residuary (noting tax and duty would be paid prior to them receiving their interest).
Marino Law has extensive experience in all aspects of estate planning. Should you require any assistance regarding the grant of a right of occupancy or a life estate or are the beneficiary of an estate that includes drafting around such concepts, please contact one of our experienced estate planning lawyers for a consultation.
