Dear Michael: Our estate is over $12 million. We have set things up for our son to receive our farmland via life estate. What happens if the estate tax laws change to $6 million per person under Biden’s tax plan versus what is happening now? How will the life estate help us or hurt us? – Already Gave It Away.
Dear Already: I imagine you set up a life estate to help Medicaid from using it as a countable asset if you should need long-term care.
That gift, however, has major consequences when it comes to estate taxes down the road. The value of his “residual deed” is deducted from your overall estate tax credit.
For example, if you were 77 at the time of the gift, IRS determines you kept 50 percent of the value of the property and the value of the deed would then be 50 percent as well. When you “gave” that to your son, an appraisal should have been done and a gift tax return should have been filed on the value of the gift – if it exceeds $15,000. Every year, you are allowed to give $15,000 ($30,000 per couple) to as many people as you like and it has no effect.
IRS has a table based on your age. The higher the age, the higher percentage is assigned to the residual deed or gift made as it is based on life expectancy tables. If you are younger, you will likely receive income longer and therefore the gift percentage isn’t as large.
When you exceed the $15,000 limit, the amount in excess is then deducted from your now $11 million credit ($22 million for a couple) by IRS. They keep your gift tax return on file to make sure they have a record of it.
The first problem is very few people got their land appraised at the time of the life estate/residual deed gift nor did they file a gift tax return at the time. Therefore, if it becomes a part of your estate tax issues upon your death and there is no appraisal, IRS will assign a value to it and it is going to be up to your heirs to prove them wrong as to the IRS assessed value. IRS is the only branch of government where you are decided to be guilty first and it is up to you to prove you are not.
If you made this life estate/residual deed move in the past five years, it is possible you can find a qualified commercial appraiser to appraise the land and you can just file a late gift tax return. There is no penalty because there is no tax due. It’s not too late to get this bit of information properly identified for IRS.
The problem in the future is this. Any residual deed you have gifted away to your son is deducted from your estate tax credit – whatever that credit might be at the time of death – not at the time of the gift.
For example, if the land is appraised at $6 million and you gave your son a residual deed in the property. At age 77 (for the youngest of you) this would mean the value of his deed would be 50 percent or $3 million. The excess over $15,000 would be deducted from your estate tax credit.
The second problem is the value of any property you maintain a life estate interest in is still included at it’s fair market value at the time of death. You receive a deduction from your credit based on the gift and, yet, the entire value is still included within your estate. You would, in the above example, still have $6 million in your estate for any life estate property.
Using a life estate when your values are close to $12 million is sketchy, at best. At worst, you may have inadvertently created more taxes for your heirs when you die due to the life estate.
Again, until the changes come – which might not happen until 2026 when this estate tax law sunsets or ends – it is hard to visualize the future. But for people to be making life estate gifts, be very wary of the possible $12 to $13 million line that’s rumored to be coming.
Michael Baron provides estate planning guidance at Great Plains Diversified Services in Bismarck, North Dakota. Email him at KeeptheFamilyFarm@gmail.com.