Life Interests and Rights to Reside

A life interest is a common gift in a Will. Spouses will often leave each other a life interest in their home, and parents will often want to ensure their child who is living with them can continue to reside in the home after they pass.

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The goal of such provisions is to ensure the accommodation for the particular beneficiary, while still distributing the underlying asset 'fairly'.

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While there are almost unlimited variations, the general idea is that A can live in the home for life, and then, when A no longer needs it, the home is sold and divided equally between  B, C and D.

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Such provisions entail some complexities for the Executor.

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Life Interest v Right to Reside

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Both 'life interest' and 'right to reside' are terms used to indicate a gift where the use and occupation of an asset (usually a home) is given to one person for a term, while the remainder (the asset remaining after the term has ended) goes to another. The 'term' of the interest is often expressed as the lifetime of the beneficiary - hence the name 'life interest'.

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Generally, a right to reside is a less extensive gift than a life interest.

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A right to reside is generally not portable (see below) and will often end before the lifetime of the gift recipient. It may be for a fixed term of years, and is often expressed to end if the beneficiary ceases to occupy the premises - that is, the beneficiary cannot move out and install a tenant and collect the rent.

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A life interest is generally for the lifetime of the beneficiary, and is portable.  A life tenancy does not require the tenant to continue to live in the property - they may move out, rent out the premises, and collect the rent. They may instruct that the property be sold and a new one purchased instead - or the sale proceeds may be invested in another way and the income from that investment paid to the life tenant.

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However, the position is complicated by the fact that the courts try to give effect to what the Willmaker actually intended - which they glean from the exact wording of the Will and, sometimes, external evidence. Willmakers are not generally aware of the legal distinctions given to terms like 'life interest' and 'right to reside', and may use the terms ambiguously. For this reason a Will provision that is termed a 'life interest' may be interpreted as meaning a lesser gift, and, similarly, a gift of a 'right to reside' may be interpreted as being a full life interest.

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When the meaning of a Will provision is unclear, a court application may be required so the executors can be guided as to how to read and construe the Will.

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At the end of a life interest or right to reside, the underlying asset is transferred to the remainder beneficiaries. The life tenant, and their estate, have no further right to the asset.

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Not Restricted to Homes

A life interest can be over any (or all) of the estate assets. While it is usually for a home that is not a requirement.  A life interest can be given over any asset which the Willmaker wants to allow their life tenant beneficiary to use or receive the benefit of, but the asset to eventually be received by different beneficiaries.

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Just as an apple is a fruit but a fruit is not necessarily an apple, a life interest may be over a home, but may also be created over any or all assets of the estate.

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Separate Handling of Capital and Income

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Fundamentally, a life interest entails the separation of the income rights and the capital rights of the gift. The life tenant receives the income, and the remainder beneficiaries receive the capital - postponed for the duration of the life interest.

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It may not seem, at first blush, that allowing a person to live in a home, rent-free, has anything to do with income. However, from an accounting perspective, the use and occupation of a home is equivalent to renting it out to the life tenant, then paying that rent to the life tenant. The 'income' in this case is not paid and reimbursed, but conceptually the income earning capacity of the home is being applied to the benefit of the life tenant.

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The capital allocation to the remainder beneficiaries is easier to follow - once the life interest has ended, either the house itself is transferred to the remainder beneficiaries, or the house is sold and the proceeds paid to them.

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Expenditure during the term of the life tenancy must also be carefully categorised. If the expenditure is of a non-capital nature - such as rates, water, insurance, levies, cleaning and general maintenance - then it is an operating expense and must be paid by the life tenant. If the expenditure is of a capital nature - such as building extensions, roof replacement, renovations and major repairs - then it is a capital expenditure and must be paid by the remainder beneficiaries.

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In this context 'paid by' does not always require the beneficiary to cash-flow their required payments to the estate - though this may be exactly how it is done. The 'payment' can also be achieved by an adjustment against the ultimate entitlements of each beneficiary (subject to the financial position of the estate generally).

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The obligation to pay is also subject to any changes to the general rule that are expressed (or implied) in the Will. The Will may direct that the life tenant's costs are paid by the estate, for example.

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Issues with Life Interests

The most common issue with life interests is the failure of the Willmaker or the Executor to properly allow for the reality that maintaining a property during the life tenancy costs money.

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If, for example, the home is left to the surviving spouse, and the rest and residue is distributed to the 3 children equally, it is a common error for the executors to pay out all of the estate funds to the residuary beneficiaries, without preserving any fund to maintain the house.

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The longer the life interest endures, the greater the likelihood that capital expenditure will be required to maintain the property in habitable condition. If the life tenant cannot, or does not, pay the ongoing costs, or if the life interest also required the non-capital costs to be paid by the estate, then a significant annual expenditure is required to maintain the property. This must be maintained for the duration of the life tenancy - a term which cannot be known in advance.

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If no fund is preserved for this purpose then a funding crisis will soon arise.

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If there is no fund available, and the life tenant cannot, or will not, meet the costs, then the home will have to be sold.

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The other significant issue with a life interest is that the administration can be delayed for a long time - decades - while the life interest continues. While estimates can be made, no-one knows how long a gift 'for life' will last, and the remainder beneficiaries' interests are postponed for the duration.

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The executor must continue to administer the estate to ensure that both the life tenant and the remainder beneficiaries' interests are preserved and maintained for the duration of the life tenancy.

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It is not uncommon to find that this is not done well, or at all, particularly in very lengthy life tenancies.

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Portability

A life interest will generally include a right of portability, while a right to reside will not.

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Portability means that the initally gifted asset can be sold, and reinvested in a new asset, and the new asset becomes the subject of the life interest in lieu of the old.

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This, too, can be counter-intuitive, as the intial gift will often make no reference to such a concept. However, when considered in light of the underlying meaning of the gitt - that a life interest is, effectively, a gift of the income produced by the asset, it is easier to understand. Selling the asset, investing the proceeds in a new investment, and paying the income from that investment to the ilfe tenant is effectively the same thing as the right to use and occupy the intial asset. If can also then be more readily understood that a life interest does not have to be over a home - a life interest over a share portfolio, or a commercial building, or even an interest-bearing deposit, works exactly the same way.

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If the interest is not portable, then the interest will cease if the initial asset is sold. This may be the stated intention in the Will, or the intention may be discerned from the overall context of the Will provisions. When unclear, a court order may be required to direct the executors as to how the will should be read and construed.

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Conclusion

Life interests and rights to reside are more complex than they initially appear, and accounting for them requires separate handling of the asset's ncome and capital.

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Attestates facilitates the correct hanlding of Life Interests and Rights to Reside - including separate allocation of income and capital - and automatically applies those distinctions when calculating each beneficiary's entitlements.

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