June 29, 2023
Life Estates
I. LIFE ESTATES
1. Definition:
a. An estate is used to express the nature, duration or extent of an interest in land. A life estate is an estate which is measured by the life of a specified person, by the joint lives of two or more specified persons, of by the last survivor of two or more specified persons.[1]
b. Right to use and occupy is not a life estate.[2]
2. Advantages of Life Estate
a.Right to live in house.
b. Removes remainder interest in the house from Medicaid estate after five (5) years of transfer.
c. Medicaid will only count the value of the remainder interest on transfer, which is a significantly lower value than if the whole were transferred.
d. Original owner still maintains full control of property and its management also retains Veterans and STAR tax exemptions.
e. Full value is included in original owner’s estate for tax purposes, but remainderman still receive a full basis step up to fair market value upon death.[3]
3. Disadvantages of Life Estate
a. Restricts ability to finance.
b. Subject to attachment of remainderman for creditors.
c. Remainderman’s interest passes by Will or intestacy.
d. Remainderman can not be changed.
e. Must wait five (5) years from the date of transfer in order ensure that the entire interest is not available for Medicaid attachment.
f. Prior to the death of original owner all parties must agree to sell property.
g. If property is sold by merging the interests, the cash from the sale of the life estate portion is attachable by Medicaid and a capital gains tax could be incurred by remainderman.
h. Loss of $250,000 exclusion for capital gains for remainderman not residing there.
i. If grantor goes into a nursing home before the five-year waiting period is up and does not return home, Medicaid could deem the life estate void for purposes of the reduced waiting period.
j. If house is sold while receiving Medicaid, the actuarial value of the life estate will be an available resource based on the IRS tables and not 96 ADM-8.
II. Loans1. A home subject to a mortgage may be transferred with reserved life estate without bank calling loan due.[4]
III. GIFT TAX CONSEQUENCES OF LIFE ESTATES
1. General
a. If a donor transfers by gift less than his entire interest in property, the gift tax is applicable to the interested transferred and the gift is complete. The tax is applicable, for example, to the transfer of a life estate when the grantor retains the remainder interest.[5]
b. If the grantor reserves a limited or special power of appointment as to the property, then the gift is incomplete to the extent of the ascertainable value of any rights thus retained by the grantor.[6] Incomplete gift still necessitates a gift tax return.[7]
2. Value of the gift
a. Value of the gift is the fair market value of the gifted property on the date the gift is made.
b. Deed transfer with a retained life estate is governed by IRC §2702. As such, the value of the retained interest is zero causing the full value of the property to be subject to gift tax if the gift is made to a family member. A family member includes a donor’s spouse, ancestor or lineal descendant of the donor and the donor’s spouse, a sibling or the donor and the spouse of such ancestor, descendant or sibling.
c. Gift splitting between spouses is allowed on life estate gift.
IV. INCOME TAX OF LIFE ESTATES
1. Rents
a. Taxed to life tenant.
2. Deduction
a. Life tenant may deduct real estate taxes and mortgage interest if actually paid by the life tenant. [8]
b. Remainderman may deduct real estate taxes and mortgage interest if actually paid by the life tenant.
3. Property sold during lifetime of life tenant
a. The life tenancy may be taxed as a trust depending on the facts and circumstances (i.e. does the life tenant hold a fiduciary relationship with respect to the remainderman to the extent that the property is not required for the life tenant’s own needs, maintenance and comfort, does the life tenant has the duty to protect and conserve the property for the remainderman?).[9]
b. Prior to Sept 26, 2011, there were three (3) ways to determine sharing of proceeds:
i. IRS tables 7520(a)[10]
ii. Medicaid agency chart[11] (now IRS chart is used Administrative Directive 11 OHIP/ADM-8)
iii. New York Courts Direct NY Commissioner of Insurance to value life estates based on the age of life tenant.[12]
c. Capital Gains Exclusion
i. Applies to life tenant assuming they resided in residence two (2) of the last five (5) years.[13] Time spent in nursing home counts. [14]
ii. Remainderman who does not meet the requirements of IRC §121 will have to pay capital gains.
iii. Allocate basis between life estate and remainderman on same percentage set forth under IRC §7520 table at date of sale.
V. ESTATE TAX CONSEQUENCES OF LIFE ESTATES
1. The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer under which he has retained for his life the possession or enjoyment of, or the right to the income from the property.[15] Therefore, the entire value of the residence will be includible in the grantor’s taxable estate
2. Even though the retention of limited or special power of appointment by the grantor causes the gift to be incomplete, the value of the property will be included in the grantor’s taxable estate.[16] Even though the life estate property included in life estate holder’s estate, there is no support in under IRC §1022 whether the property will receive a step-up in basis during 2010. For all other years any property included in the gross estate receives a full step up in basis.[17]
[1] Horner Probate Practice and Estates §74:1
[2] Bartholomew v. Horan, 37 A.D.2d 643, 322 N.Y.S.2d 401, N.Y.A.D. (1971)
[3] Not applicable for death occurring in 2010 unless electing Estate Tax.
[4] 12 U.S.C.A §1701j-3(d)(6): prohibits lender from calling loan if property is transferred to a spouse or child (or in trust for the benefit of the grantor 12 U.S.C.A §1701j-3(d)(8)).
[5] Treas. Reg. § 25.2511-1(e)
[6] Treas. Reg. § 25.2511-2(b) and (c)
[7] Treas. Reg. §25.2511-2(j) and Treas. Reg. §301.6501(c)-1(f)(5): a grantor must report incomplete gifts if he takes position that the transfer is not subject to gift tax.
[8] IRC §163 and IRC § 164
[9] U.S.v. De Bonchamps, 278 F.2d 127 (C.A.9 1960)
[10] Revenue Ruling 71-122
[11] 96 ADM-8
[12] In re Sauer, 195 Misc.2d 232, 757 N.Y.S.2d 709, N.Y.Sur. (2003)
[13] IRC §121
[14] IRC §121(d)(7)
[15] IRC §2036(a)(1)
[16] IRC §2036(a)(2)
[17] IRC §1014
*** The Treasury Department has newly promulgated Regulations effective June 20, 2005, that applies to those attorneys and accountants (and others) practicing before the IRS that require such individuals to provide extensive disclosure in certain written communications to clients. In order to comply with our obligations under these Regulations, we want to inform you that since this communication is not intended to and does not contain such disclosure, you may not rely on any tax advice contained in this document to avoid tax penalties.
I. LIFE ESTATES
1. Definition:
a. An estate is used to express the nature, duration or extent of an interest in land. A life estate is an estate which is measured by the life of a specified person, by the joint lives of two or more specified persons, of by the last survivor of two or more specified persons.[1]
b. Right to use and occupy is not a life estate.[2]
2. Advantages of Life Estate
a.Right to live in house.
b. Removes remainder interest in the house from Medicaid estate after five (5) years of transfer.
c. Medicaid will only count the value of the remainder interest on transfer, which is a significantly lower value than if the whole were transferred.
d. Original owner still maintains full control of property and its management also retains Veterans and STAR tax exemptions.
e. Full value is included in original owner’s estate for tax purposes, but remainderman still receive a full basis step up to fair market value upon death.[3]
3. Disadvantages of Life Estate
a. Restricts ability to finance.
b. Subject to attachment of remainderman for creditors.
c. Remainderman’s interest passes by Will or intestacy.
d. Remainderman can not be changed.
e. Must wait five (5) years from the date of transfer in order ensure that the entire interest is not available for Medicaid attachment.
f. Prior to the death of original owner all parties must agree to sell property.
g. If property is sold by merging the interests, the cash from the sale of the life estate portion is attachable by Medicaid and a capital gains tax could be incurred by remainderman.
h. Loss of $250,000 exclusion for capital gains for remainderman not residing there.
i. If grantor goes into a nursing home before the five-year waiting period is up and does not return home, Medicaid could deem the life estate void for purposes of the reduced waiting period.
j. If house is sold while receiving Medicaid, the actuarial value of the life estate will be an available resource based on the IRS tables and not 96 ADM-8.
II. Loans1. A home subject to a mortgage may be transferred with reserved life estate without bank calling loan due.[4]
III. GIFT TAX CONSEQUENCES OF LIFE ESTATES
1. General
a. If a donor transfers by gift less than his entire interest in property, the gift tax is applicable to the interested transferred and the gift is complete. The tax is applicable, for example, to the transfer of a life estate when the grantor retains the remainder interest.[5]
b. If the grantor reserves a limited or special power of appointment as to the property, then the gift is incomplete to the extent of the ascertainable value of any rights thus retained by the grantor.[6] Incomplete gift still necessitates a gift tax return.[7]
2. Value of the gift
a. Value of the gift is the fair market value of the gifted property on the date the gift is made.
b. Deed transfer with a retained life estate is governed by IRC §2702. As such, the value of the retained interest is zero causing the full value of the property to be subject to gift tax if the gift is made to a family member. A family member includes a donor’s spouse, ancestor or lineal descendant of the donor and the donor’s spouse, a sibling or the donor and the spouse of such ancestor, descendant or sibling.
c. Gift splitting between spouses is allowed on life estate gift.
IV. INCOME TAX OF LIFE ESTATES
1. Rents
a. Taxed to life tenant.
2. Deduction
a. Life tenant may deduct real estate taxes and mortgage interest if actually paid by the life tenant. [8]
b. Remainderman may deduct real estate taxes and mortgage interest if actually paid by the life tenant.
3. Property sold during lifetime of life tenant
a. The life tenancy may be taxed as a trust depending on the facts and circumstances (i.e. does the life tenant hold a fiduciary relationship with respect to the remainderman to the extent that the property is not required for the life tenant’s own needs, maintenance and comfort, does the life tenant has the duty to protect and conserve the property for the remainderman?).[9]
b. Prior to Sept 26, 2011, there were three (3) ways to determine sharing of proceeds:
i. IRS tables 7520(a)[10]
ii. Medicaid agency chart[11] (now IRS chart is used Administrative Directive 11 OHIP/ADM-8)
iii. New York Courts Direct NY Commissioner of Insurance to value life estates based on the age of life tenant.[12]
c. Capital Gains Exclusion
i. Applies to life tenant assuming they resided in residence two (2) of the last five (5) years.[13] Time spent in nursing home counts. [14]
ii. Remainderman who does not meet the requirements of IRC §121 will have to pay capital gains.
iii. Allocate basis between life estate and remainderman on same percentage set forth under IRC §7520 table at date of sale.
V. ESTATE TAX CONSEQUENCES OF LIFE ESTATES
1. The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer under which he has retained for his life the possession or enjoyment of, or the right to the income from the property.[15] Therefore, the entire value of the residence will be includible in the grantor’s taxable estate
2. Even though the retention of limited or special power of appointment by the grantor causes the gift to be incomplete, the value of the property will be included in the grantor’s taxable estate.[16] Even though the life estate property included in life estate holder’s estate, there is no support in under IRC §1022 whether the property will receive a step-up in basis during 2010. For all other years any property included in the gross estate receives a full step up in basis.[17]
[1] Horner Probate Practice and Estates §74:1
[2] Bartholomew v. Horan, 37 A.D.2d 643, 322 N.Y.S.2d 401, N.Y.A.D. (1971)
[3] Not applicable for death occurring in 2010 unless electing Estate Tax.
[4] 12 U.S.C.A §1701j-3(d)(6): prohibits lender from calling loan if property is transferred to a spouse or child (or in trust for the benefit of the grantor 12 U.S.C.A §1701j-3(d)(8)).
[5] Treas. Reg. § 25.2511-1(e)
[6] Treas. Reg. § 25.2511-2(b) and (c)
[7] Treas. Reg. §25.2511-2(j) and Treas. Reg. §301.6501(c)-1(f)(5): a grantor must report incomplete gifts if he takes position that the transfer is not subject to gift tax.
[8] IRC §163 and IRC § 164
[9] U.S.v. De Bonchamps, 278 F.2d 127 (C.A.9 1960)
[10] Revenue Ruling 71-122
[11] 96 ADM-8
[12] In re Sauer, 195 Misc.2d 232, 757 N.Y.S.2d 709, N.Y.Sur. (2003)
[13] IRC §121
[14] IRC §121(d)(7)
[15] IRC §2036(a)(1)
[16] IRC §2036(a)(2)
[17] IRC §1014
*** The Treasury Department has newly promulgated Regulations effective June 20, 2005, that applies to those attorneys and accountants (and others) practicing before the IRS that require such individuals to provide extensive disclosure in certain written communications to clients. In order to comply with our obligations under these Regulations, we want to inform you that since this communication is not intended to and does not contain such disclosure, you may not rely on any tax advice contained in this document to avoid tax penalties.