Question about tax implications of life estate deed

Previous | Next
 rated by 0 users
Latest post 02-08-2012 5:36 PM by Taxagent. 14 replies.
  • 02-06-2012 9:44 AM

    Question about tax implications of life estate deed

    My Dad passed away in August.  One year before his death he changed his will and left everything to his new wife.  My family was shocked and we decided to fight it with the help of a lawyer.  Although we did not formally contest the will, we did convince the new wife to sign a life estate deed agreement, giving me (only child) ownership of the family home and giving her the right to live there until she dies.

    My question is:  for tax purposes, can the house (and the value thereof) be considered an inheritance from my Dad or is it a gift from his wife?  If it is a gift from his wife to me, is there a limit on the value gifts from a non-blood relative (she is my step-mother) for tax paying purposes?

    To complicate matters further, I live and work overseas and claim the foreign earned income tax exclusion.  Is the value of the house considered income of some sort? 

  • 02-06-2012 10:08 AM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    Laymans guess:

    1. It is not a gift.

    2. In my state (PA) the value transferred to you by estate, computed in part by her life expectancy,  would trigger an inheritance tax the executor needs to pay--but I simply don't know what state tax issues exist in NY--that's for executor to sort out. Wife's share would be free in my state.  There may be other ways to address sequence of events.

    3.There is no income component to address.

    As an aside , as remainder-man you might be wise to insure your interest in the home.



  • 02-06-2012 10:49 AM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    Sorry--you may not be in NY--use correct state as to state tax issues.



  • 02-06-2012 10:53 AM In reply to

    Re: Question about tax implications of life estate deed

    My question refers only to federal taxes as I am not required to pay any state taxes (foreign resident)

  • 02-06-2012 11:13 AM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    Don't assume too much! 

    Would not matter if you lived on Moon, in my state the transfer of property to anybody but the spouse would trigger a hefty state inheritance tax payable by executor for estate  --in the magnitude of 15% --state laws do matter!

    Its state where Dad passed or property is located that matters.

    And if in PA one did not pay proper attention to property transfer laws you could get up to a 4% transfer tax added to equation.

    For a modest size estate I think less than 5 million for 2011, there would be  no federal estate taxes  unless there were massive earlier gifts

    There might be no state tax issues in your particular fact /state pattern but its unwise to just jump to that conclusion.



  • 02-06-2012 11:14 AM In reply to

    Re: Question about tax implications of life estate deed

    DietColaLola:
    My question is:  for tax purposes, can the house (and the value thereof) be considered an inheritance from my Dad or is it a gift from his wife?

    Your facts were that his wife inherited the house under the will, and then she (not the estate) transferred to you the remainder interest in the house, while she reserved a life estate for herself, right? Under those facts, she made a gift to you of the remainder interest in the home.

    DietColaLola:
    If it is a gift from his wife to me, is there a limit on the value gifts from a non-blood relative (she is my step-mother) for tax paying purposes?

    Under federal gift tax, if the value of the remainder interest she passed to you was over $13,000, then she must file a federal gift tax return. Unless she's used up her lifetime credit against federal estate and gift taxes (currentlly $5 million, but will return to $1 million at the beginning of next year unless Congress changes the law), then all that happens is she uses up some of her credit — no tax is actually paid until she uses up that credit.

    As the person receiving the gift, you don't pay any gift tax so you don't have to worry about that.

    DietColaLola:
    To complicate matters further, I live and work overseas and claim the foreign earned income tax exclusion.  Is the value of the house considered income of some sort? 

    Gifts are not income to you for income tax purposes, either.

    You do need to figure out what your basis in the remainder interest is as you will need that to compute your gain when you later sell the property. She got the property with a stepped up basis in it because she inherited the property (I assume she was not a co-owner of it or she'd not have settled for a mere life estate.) So, an appraisal of the current value should suffice to establish her basis. You'll want that for documentation to back up the basis you use later—current appraisals are more convincing than one done years later when the IRS is challenging your return. Then that basis needs to be allocated between the life estate and the remainder interest. That's done proportionally based on the values of the two interests. For example, if the property were worth $100,000 and the life estate was worth $20,000 and the remainder interest was worth $80,000, then the basis of the remainder interest is $80,000 and the basis of the life estate interest is $20,000 (since, in this case, the basis of the property is equal to the value of the property). See IRS publication 551 on basis for more information on that.

  • 02-06-2012 11:42 AM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    If factually the executor settled the matter in lieu of litigation  and the executor's deed passed in two parts-- remainder man's interest to you  and life estate to her  _ I think a different  analysis might apply--results may come out about the same. And there might be some state specific analysis as to did spouse get 100% equitable title by will first.

    If title in its entirely was delivered to her and she settled possible litigation with you by delivery of a remainderman deed to you and reserving a life estate for herself--I'm as a layman not thinking that's a "gift"  --major element of quid pro quo.

    Which way did executor cut the Gordian Knot?

    I think either was the  basis computations come out the same---but perhaps not state tax issues and you didn't tell us what state. .



  • 02-06-2012 12:38 PM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    And you most certainly are obligated to make sure  local real estate taxes get paid--if life tenant is unable to do you you risk losing your remainermans position if taxes go unpaid.

    And while a tenant is not supposed to lay waste to the property they may not be required to maintain it either nor to insure it  for your benefit.

    And an impoverished tenant could probably run up a couple of years worth of unpaid taxes and  select utilities that run with land --and upon passing with an empty pot,  you'd need to pay them all off

    And if she lives another 35 yers, yours could be along wait.

    So do not assume you just got a bed of roses.



  • 02-06-2012 1:39 PM In reply to

    Re: Question about tax implications of life estate deed

    Drew:
    Would not matter if you lived on Moon, in my state the transfer of property to anybody but the spouse would trigger a hefty state inheritance tax payable by executor for estate  --in the magnitude of 15% --state laws do matter!

    First of all, it appears that the wife inherited it and then made a gift of the remainder interest to the poster. Even in PA, that would mean no inheritance tax and there is no PA gift tax. So, if he were in PA this fact pattern would be good for him. About all that would happen is a possible title transfer tax.

    Second, bear in mind that in just about every state, the estate pays the inheritance and gift taxes, not the beneficiary.

    Drew:
    There might be no state tax issues in your particular fact /state pattern but its unwise to just jump to that conclusion.

    It's always good to consider any state/local tax issues, but here I think it's likely that the main tax impact, both federal and state, is likely to come when he sells the property somewhere down the line.

  • 02-06-2012 2:17 PM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    I'm having trouble accepting that the transfer of a remainderman deed was a true gift and not some sort of settlement --the federal tax issues and tax basis  might be the same  for smaller estates and thus moot. .

    The inheritance tax for a relative but not by blood or adoption is probably 15% in PA--on the value of the remaindermans share  IF it was a transfer by estate . But 0% if a transfer from spouse who inherited it.

    Actually PA does tax gifts if by circumstance the donor dies within 1 year of making the gift --rare--but not unheard of with older people ---probably moot here too--- if spouse lives but `1 year after  the trnasfer. .

    I'm not so sure  a local  PA county tax office  is equipped to sort out transfer tax issues unless somebody delivers same on a silver platter to them. I think for most counties its but 2% --Philadelphia is 4%

     

    So far OP doesn't even address relevant state-------



  • 02-06-2012 11:33 PM In reply to

    Re: Question about tax implications of life estate deed

    The house is in Nevada and now registered to me via Clark County, NV registrar's office.  According to the lawyer who drew up the life estate deed and also the registrart, the only taxes I will have to pay on the house in the state will be property taxes after the 2nd wife dies.

  • 02-07-2012 12:04 AM In reply to

    Re: Question about tax implications of life estate deed

    DietColaLola:
    The house is in Nevada and now registered to me via Clark County, NV registrar's office.

    Nevada is about as friendly as it gets for state death taxes -- it has none. For you, though, it would still be better if this can be cast as an inheritance to her and then a gift to you of the remainder interest. Although that creates a gift tax return filing obligation for her (though not likely the payment of any gift tax), it would ensure a better basis for you should you guys hold the property until she dies. If she is the one who transferred the property and created the life estate (i.e. a gift to you from her) then when she dies, you get a step up in basis to fair market value on the whole property. If the life estate to her and the remainder interest to you were created from the estate, then when she dies you won't get that step up, and could mean a lot more capital gain tax to pay.

  • 02-07-2012 2:10 AM In reply to

    Re: Question about tax implications of life estate deed

    Taxagent:

    If she is the one who transferred the property and created the life estate (i.e. a gift to you from her) then when she dies, you get a step up in basis to fair market value on the whole property.

    First of all, thank you for your helpful comments.  It is exactly as you noted above.

    And to be honest,  I don't care if she has to pay taxes or not as she basically duped my Dad (who was at the time suffering from Alzheimers and died of Dementia according to the death certificate) into changing his will.  It was done by her attorney and financial advisors.  She inherited PLENTY of money to pay whatever taxes come her way.

     

  • 02-07-2012 9:14 AM In reply to

    • Drew
      Consumer
    • Top 10 Contributor
    • Joined on 03-30-2000
    • PA
    • Posts 49,498

    Re: Question about tax implications of life estate deed

    You post that your deed was from her direct and you may well be correct . But if she has plenty of money  like well above $1 million  and she used good tax counsel then the other sequence of the deed to you comming direct from estate  might have made more sense for her future estate. --it has to do with the conveyance of a future interest is not a completed gift, she retains dominin and control until she passes, an incomplete gift gets recaptured  --and beyond that you need taxagent to comment.

    Of course to some extent you don't care if her side got it wrong for them.

    It certainly seems like there are no current  tax or income tax issues on your plate.

    Hint for future when property becomes yours alone.  At least under current law--your tax and cost issues to address handing of property held for investment/rental purposes are far more liberal than for  how one hold personal property , especially property that is not ones primary residence  for a number of years.



  • 02-08-2012 5:36 PM In reply to

    Re: Question about tax implications of life estate deed

    Drew:
    --it has to do with the conveyance of a future interest is not a completed gift, she retains dominin and control until she passes, an incomplete gift gets recaptured  --and beyond that you need taxagent to comment.

    You've made two incorrect statements there. First, a gift of a future interest is a completed gift — an incomplete gift and a gift of a future interest are very different things. It is correct that a transfer of property with the retention of a life estate is a gift of a future interest because the remainderperson does not get immediate use and possession of the property. The effect of it being a future interest is that the $13,000 annual gift tax exclusion cannot be applied to that gift. The annual exlusion only applies to gifts of a present interest in property.

    It is not an incomplete gift. The deed was delivered and recorded. The remainderman has a legal enforceable interest in the property. He can sell, mortgage, devise, etc., his interest in the property. He could not do that if the gift was not complete because with an incomplete gift he owns nothing. That brings me to the second error, which is that incomplete gifts are not "recaptured." If it were an incomplete gift, there is no need to drag the asset back to her estate because with an incomplete gift the property never left the estate in the first place.

    The reason that the entire value of the property is included back into the estate of the life tenant in that case is that IRC § 2036 says that transfers of property with a retained life estate result in inclusion of the value of that property in the donor's estate when she dies. That's it, it's just a very specific provision of the Code. But it is precisely the inclusion under IRC § 2036 that will give the OP a stepped up basis in the property under IRC § 1014 as of the date she died. Thus, if the fact pattern is that she inherited it and then made a gift of the property to him while retaining a life estate, under present tax law that's going to give him a better income tax result overall than had he inherited his remainder interest directly from the estate.

Page 1 of 1 (15 items) | RSS

My Community

Community Membership New Users: Search Community