Life Estate Deed

[mptax]

Life Estate deed created by 2 Life Tenants with 4 Remainders.  One L.T. dies after 10 yrs.  House is sold 6 yrs later while 2nd L.T. and 4 Remainders are still alive.  How does the step-up in basis from the L.T. who died allocated?

[BobKamman]

Trick question, right?  Because what makes you think there should be any stepped-up basis?

https://lawprofessors.typepad.com/agriculturallaw/2018/08/life-estateremainder-arrangements-and-inco... 

[mptax]

Life Tenants bought the house many years as tenants by the entirety before they put the house into a Life Estate Deed.  Doesn't the date of death value of the house on the death of one of the Life Tenants go to the other Life Tenant or to everyone involved in some proportion?

[BobKamman]

Did they ask that question when they did it?  Probably not -- most of these "hillbilly probate" arrangements are done specifically to avoid professional advice.  

[mptax]

No one asked.  And now I’m stuck with trying to figure out how to account for the sale on the returns of the remaining Life Tenant and the Remainders

[BobKamman]

The best approach may be to use "substance over form."  Did the parents really intend for the kids to have a marketable interest in the property?  Did the kids even know they were given a remainder?  Or should the sale be reported 100% on the mother's return -- presumably she qualifies for the $250K exclusion?

But were multiple 1099-S's issued to all five parties?  Who get the money?  If the kids got a check, did they turn the money over to their mother, or is this part of a scheme where the kids get cash to go on a cruise and Mom gets to stay at the county home at taxpayer expense?  

And whose return are you doing -- Mom's?  A kid?  Some or all of the others?  

If the family weren't allergic to professional advice, they could have avoided the problem by deeding the remainder interests back to Mom before the house was sold.   

[mptax]

All good questions.  Deed was to avoid probate.  Kids knew they were remainders.  Mother gets $250K exclusion but she receives only a percentage of the selling price as there is a chart based on age to calculate her take of the proceeds.  Remainders split the rest of the proceeds equally.

Sale is pending but kids expect checks which they will keep.  Mom is now living with a daughter so house is vacant.  But mother lived in house for at least 2 of the past 5 years.

Doing Mom's return plus one of the kid's.

Too late to deed interests back.

[BobKamman]

If the sale is still pending it's not too late.  But if the kids want the cash, then let them pay some tax.  

[mptax]

Right.  And as I'm seeing it, they have zero basis unless some of the closing costs are allocated to them in the same manner that the selling price is allocated.

[qbteachmt]

"Doesn't the date of death value of the house"

The person who died did not own a house. They owed the Life Estate or Right to live there. There is no step up in basis for something they no longer owned.

[mptax]

So what you're saying is that no one owns the house?

[BobKamman]

Have you seen the deed that created the life tenancies and remainder interests?  I'm wondering if it says the parents' interest is held as joint tenants.  Were they joint tenants before they did this?  I think you wrote something about "tenants by the entirety" but that only happens in strange places and I don't know much about it.  If they owned it as tenants in common (which could happen if under state law, the attempt at joint tenancy was defective)  then maybe the kids have owned half of it since Dad died, and just didn't know it.  And their basis would be stepped up at his death.  

[sjrcpa]

Tenants by the entirety is reserved for married couples. We have it in MD. The married couple entirety is one owner. When one spouse dies it goes to the other spouse.

It can be changed to tenants in common. Frequently done before transferring to a trust.

[mptax]

I've been trying to get some information from a lawyer in NY where the property is situated but so far no response.  From what I've read, there are 2 separate forms of ownership.  The Lifetime Owners and the Remainder Owners. .The later may only become owners upon death of the last to die of the Life Tenant Owners.  Was hoping someone in this community might know more about how IRS treats this situation.

[BobKamman]

New York estate-planning lawyers seem to have a thing for life estates with remainders, that you won't find elsewhere in the country.  I think it's "let's keep our archaic probate laws that cost so much to administer so that we can sell people ways to get around them."  California has the same attitude, except there they like to sell inter vivos trusts.  (It's easier when you don't use Latin.)  Then, since much of the national media are located in New York and California, the writers in backwards states try to inform the rest of the country on what works.  

[mptax]

Yes.  I try to tell people not to go this route.  The original owners lose control over their property to their children who don't necessarily care about doing what's best for their parents.  And the tax results can make everyone crazy if the property is sold before Lifetime Owner's death.  Seems to me a Family Trust is somewhat better if you want to protect assets.

[BobKamman]

Just move to Florida, where you have an unlimited homestead exemption.  Otherwise, "asset protection"  is a term favored by con artists.  

[qbteachmt]

"is that no one owns the house?"

That's not what you told us. You told us there a 4 remaindermen (owners) and 2 life tenants (occupants), and that one of the LT died. That person no longer owned the home when they formed the Life Estate; they only owned the right to live there. And the remaindermen already own the property from that formation as well, which is why the death of a LT does not result in a step up in basis.

Don't confuse Possession and Ownership. Here is a nice explanation:

"The person holding the life estate -- the life tenant -- possesses the property during his or her life. The other owner -- the remainderman -- has a current ownership interest but cannot take possession until the death of the life estate holder."

[qbteachmt]

"The later may only become owners upon death of the last to die of the Life Tenant Owners."

They Take Possession, but already owned it.

[mptax]

All the information that can be found on the internet makes this issue confusing which is why I'm looking for what to do on the tax return from other accountants..  A web site by Susan M. Mooney, Esq. talks about the 2 forms of ownership but the question remains how IRS will treat this situation.  She says "The Remainder owner(s) automatically become owner(s) of the subject real estate immediately upon the death of the last to die of the Life Tenant Owner(s)."  She talks about the Life Tenant as being an owner "The Lifetime Owner of the property with absolute and exclusive right to use of the property during their lifetime, which expires automatically upon the death of the last to die of the Life Tenant(s)."  I don't know this woman and I don't know if she's correct.

Where did your explanation come from?

[mptax]

I agree with moving to Florida to avoid this house issue.  When other assets are "protected" the grantor is always subject to constraints that are often confusing and difficult or impossible to change when circumstances change.  Sometimes that's good and sometimes that's bad depending on perspective.

[qbteachmt]

You have to find the legal point of Property Ownership transfer. It doesn't keep transferring on death, so there is no step up, when it is already in a Trust or already Transferred or the names got added to the Deed. That's where people go wrong, and do stuff well-intentioned, but without legal guidance.

We've seen that on this forum, such as where the Daughter sold a house that she was originally on the deed (and helped buy) with both parents, then the parents put the house into their trust. Then they died. It's hard to address the proper tax treatment for that sale for the daughter, when essentially, someone who did not solely own the house stole it from that third person by putting it in the trust. She wanted a step up in basis for a home she didn't inherit, as well, if I remember all the issues. It's already in the Trust. She might be the beneficiary of the trust, but she neither owned nor inherited the home that was stolen from her.

In a nutshell.

[mptax]

Thank you.

[mptax]

For those of you who are interested in this issue:

I spoke with a lawyer in New York today who was able to tell me the procedure to assign the amount each person receives from the sale of the house (Life Tenant and Remainders) and how to apportion basis.

IRS puts out a table called Life Estate and Remainder Interest Tables.  It is based on the age of the Life Tenant at the time of sale.  The percentages are what they are entitled to and what the Remainders are entitled to.

According to the lawyer, start with the Gross Sales Price.  Subtract all Selling Expenses.  Apply the appropriate percentages to determine how much money the Life Tenant receives and how much is to be split among the Remainders equally.

Then subtract out the original purchase price and purchase costs when the Life Tenants purchased the house.  Subtract out the cost of all Capital Improvements that were made to the house from the time the house was purchased to the time it is sold.

Subtract any costs to get the house ready for sale.

The net resulting basis is to be apportioned to Life Tenant and Remainders according to the same percentages used when determining how much money each person will receive upon sale.  

Also the Life Tenant may use the home capital gain exclusion if they otherwise qualify for it.

Hope this helps.

I do have another question now - how can I come up with a dollar value for capital improvements for a home that was owned for the past 65 years?  I have some idea as to things that were done but I don't have any receipts.  Any thoughts?

[qbteachmt]

"how can I come up with a dollar value for capital improvements for a home that was owned for the past 65 years?"

Funny: I just had that discussion with someone over the weekend. Does the living life tenant know what was improved? Were these kids raised there? Obviously, over that amount of time, a lot is repairs/replacement. Someone has an idea what was original to the property; there might be some useful records in the county files.

"I have some idea as to things that were done"

Heck, my clients' "new kitchen remodel" was 20 years ago, at this point.

My clients added a pool right away, for example, to the neighborhood sales office/model home they bought around 1962 (they raised 6 kids there). So, in their case, they intend to use the additional cost for "pool and amenities" to be added to basis along with the adjoining perimeter fence.

Everything else either was already there, or has been replaced over time as it wore out. In the past 8 years, they've replaced a barrel tile roof, the sewer line, the pool was changed from chlorine to saline, and I think they are on their third pool cage. The mechanicals and the additional two pool cages are repairs/replacements, not additional improvements.

[BobKamman]

That seems like the long way around the barn, but at least it answers your question about stepped-up basis.  There ain't none.  Well, at least in one person's opinion.  

If IRS had a tax on shame, the kids who want to take the money from their elderly mother would certainly be liable.  

[mptax]

The Life Tenant can't remember anything but the kids were raised there.  They know some of the improvements but without any records we have nothing to definitely say what the cost was.  I'm sure the IRS will accept some reasonable amount but knowing what was reasonable for 1960 is difficult.  That's why I was wondering if anyone knows of some guidelines that IRS may follow.

[mptax]

Very true about the stepped-up basis.  His application of the mechanics makes sense, at least in my opinion.  

At least the mother won't have to pay any capital gains on her share of the money and the kids will (both federal and state).  What was upsetting was that they were fine with her paying all the yearly expenses on the vacant house after she moved out and stopped benefitting 2 1/2 yrs ago.  The kids were expecting to benefit from her paying to keep the house in decent condition and not pay any taxes when she dies - whenever that might be.