Dear Michael: A few years ago, we set up a life estate for our land. Now we are wondering what the tax implications might be for doing so. At the time, we just put our children’s names on it thinking that is all we had to do. We are closing in on the five-year look back period and would hate to redo it all. Are we okay regarding any new estate tax changes that might be forthcoming? Almost To the Finish Line.
Dear To the Finish Line: Life estates are a different animal when compared to other estate planning techniques.
Why? Because the total value of the taxable estate will include the total value of your land at the time of death of the life estate holder. Because most life estate holder’s use a joint tenancy right on the income and use – or life estate – it means the entire value of the land will be included for estate tax purposes on the second to die estate.
This Estate Tax Credit is a difficult number to pin down right now. When Trump was president, he raised this number up to $11 million per person with a Cost-of-Living Adjustment or COLA, as it is known. This is now up to $11.5 million – after COLA adjustments.
However, it is being suggested to drop this number to either $1 million, $5 million, or back to its original amount of $5 million per person before Trump suddenly raised it. With COLA, the Estate Tax Credit is now up to about $6.5 million per person.
When you set up the life estate there was a sizeable gift involved – this being the gift of the “residual interest” in the property to your children.
This gift is a factor of your age at the time of the gift as well as the value of the gift at the time given or registered. IRS has a Life Estate Table (easily found on Google) to determine what factor you should have used based on the youngest age of you and your spouse at the time.
To be in step with IRS, a gift tax return for the value of this gift needed to be submitted to IRS at the time of the change of ownership. Without proof, IRS will assess a value and it is up to you to prove them wrong – if you think it is too high.
The value of this gift is deducted from either your current $11.5 million-dollar estate tax credit at death, or from whatever number they may change it to in the future. If they drop it down to $1 million, a lot of people are going to be in trouble. The “life estate” is an asset that hangs there in value, and no one knows how much trouble it will be based on the uncertainty of the Estate Tax Credit.
If they lower it to $6.5 million, you will have to use the IRS factor of the value used at the time of the gift which will equal X amount. Then, subtract the estate tax credit amount and add in the total value of the asset (land) today to see if you exceed the estate tax credit.
Now this is something which may be beyond the average person and or the typical advisor you may turn to for help.
If the total value of your land is over $4 million dollars in life estate, you should meet with an advisor to stay on top of any upcoming changes in the estate tax credit. I am sure you will hear about this change either in farm magazines, or the news, or even in the coffee shop.
Once you hear about this, take a hard look at the value of the assets in the life estate in addition to all other assets you might own and have someone help you determine the estate tax credit you lost when you gifted the residual interest to your children.
Lastly, for people who have set up a life estate with their children, find a way to divide the assets equally between the children and do not make them joint owners in the property. If you have them as joint owners, the day you die will be the beginning of the war in your family. It is best to get them to come together, decide who gets what parcel, and how the values add up.
If there is some inequity between parcels and you are counting on using savings, retirement funds or some other assets to offset the values, you better find a way to insulate these from long-term care costs, as well.
It is all you have left, and it will be the first to go if you need care leaving none to the children to sort out their inequities.
Michael Baron provides estate planning guidance at Great Plains Diversified Services in Bismarck, North Dakota. Email him at KeeptheFamilyFarm@gmail.com.