Retained life estate

It depends on exactly what was done and how. But I'd guess that son's estate might very well be required to include the portion of what he owns, even if the entire value of the property would have been required to be included in Mom's estate of she died first. This is actually fairly obscure (though fairly common with joint tenancies) and may actually end up being a pretty complicated question to answer, so you'd better see someone locally who can really look into it for you. Stu

Why wouldn't son's estate be required to include something? His estate now owns 1/4 of the property. The estate just can't take possession until mom passes. But when she does pass the 1/4 the house will be owned by the son's estate or by whoever the son named as his beneficiary. The son has a remainder interest. See Regulation 20.2031-7.

There's really only one reason I can think of, and that is that, if the mother were to die first the entire value of the property would be in her estate. So if she is treated as owner of the whole thing, there isn't anything left for the kids. This is the approach taken with joint tenancy property. If one joint tenancy provides all the consideration for buying the property in the first place, it's all in her estate if she dies first. If her son/joint tenant were to die first, none of it would be considered part of his estate. The joint tenancy rule, however, is based on the specific provisions of section 2036. There are no comparable statutory provisions dealing with life estates. As a result, the rule is likely not to apply to life estates, and the actuarial value owned by the son should be included in his estate if he were to die first. Contributor Perry1 claims that there are many commentators and scholarly treateses that say the value of a remainder interest should not be included in the son's estate under these circumstances. However he has declined to name even one of these, or supply any other support for his position. Stu

Is there any interaction with these provisions in determining whether a completed gift is made at the time mom changes title to joint tenancy with son for no consideration? Or is that a separate facts and circumstances question? Dan Lanciani ddl@danlan.*com

Under section 2036, for joint tenancies between unmarried people ownership is based solely on the consideration each paid. When the gift is complete is irrelevant for this purpose because even when there has been a completed gift it's treated as if it didn't happen for tax purposes. Stu

2036 doesn't discuss joint tenancies. It discusses retained life estates. The two are different. Joint tenancies are discussed in 2040. The gift is considered as complete in many, but not all, joint tenancy situations. It just is still drawn back into the estate if the grantor of the joint interest provided all the consideration. Then a credit is computed for the prior gift tax paid, if any. See 25.2511-1(h)(4) and (5). In 25.2511-1(h)(4) the original owner adds a joint owner to his bank account. The original owner is still considered the owner of the entire account for gift tax purposes, until the new joint owner withdraws funds. This is because the original owner can unilaterally take back the gift. In 25.2511-1(h)(5) the original owner adds a joint owner to real estate. This is a completed gift for gift tax purposes but not for estate tax purposes (see 2040). That is why a credit is allowed for the previously paid gift tax, to avoid the double tax. In both examples I am assuming that the two joint owners are not spouses. Rules for spouses are different.

snip

I see I didn't transition very well here. The prior paragraph mentions the estate tax Code sections on joint tenancy and retained life estates. The next paragraphs discuss the gift tax Regulations on joint tenancies. The actual gift tax Code section is obviously 2511. Sorry about that.

Whoops! You're right.

Stu

If no gift tax was paid but only a portion of the lifetime exclusion consumed does the estate get "credit" for that as well? Does the entire property enjoy the basis step up? Are there any issues if the value of the property changed significantly between title change and death (in particular if it went down)?

I'm trying to understand why popular wisdon says that passing title by joint tenancy is bad for tax purposes. I understand the non-tax issues... Dan Lanciani ddl@danlan.*com

There is no credit as there was no gift tax paid. The "lifetime exclusion" is, in effect, restored for the amount used on that gift tax return. The property is stepped up to the full fair market value at date of death or the alternative date, if elected. To the professionals, I realize these aren't the same terms we typically use. I am just trying to get at the gist of the matter.

In a manner of speaking. On death the gift tax and estate tax are in effect melded into one, taxing the current estate and all past taxable gifts, with credit for gift taxes already paid.

If joint tenancy property is all considered to belong to the decedent for estate tax purposes, the answer is yes.

Issues? I don't understand what you're getting at. The tax effects don't change.

This is particularly an issue in community property states.

With respect to husbands and wives, joint tenancy property is considered owned half by each. So when one dies only half gets the stepped up basis. On the other hand if the property were left as community property (which can be done by using a trust), the entire value of the property, not just half, gets the stepped up basis. For children the same kind of thing can happen. If a parent puts property in joint tenancy with a child for purpose of passing title on death, and in exchange the child takes care of the parent, that could be thought to be consideration in exchange for the ownership interest in the property. To the extent the joint tenancy is in exchange for consideration, the "purchaser" becomes an owner for tax purposes. And the portion "owned" by the child does not get a stepped up basis when the parent dies. Stu

If you previously paid gift tax because you exceeded the lifetime gift number but your estate (with add back) is under the estate tax number do you get a refund of the credit? (The "unified" gift and estate tax magic number for gifts is still just $1M, right?)

I was thinking that you might have a credit with respect to a past gift that exceeds the tax that would be due on its reduced value in the estate. (Or is the value that is included in the estate the value that was used at the time of the taxable gift?) This seems like the kind of thing that often provokes special rules that insure that you lose both ways, e.g., limiting the credit to the lesser of the past tax paid and the present tax that would be due.

How is the portion owned by the child determined? Is it the portion of the property at fair market value that could be bought by the fair market value of the care? Or can a below-market transfer (with the difference as gift) be inferred to pessimize the tax result? If the title is initially changed merely for purposes of passing on death and the child subsequently cares for the parent does the gift retroactively become a "purchase" for consideration?

Dan Lanciani ddl@danlan.*com

I haven't had this come up so I don't specifically know. My guess is that you don't get anything back, but you just get a (non-refundable) credit.

That's normally the way it works with lots of different taxes. You can get a credit, but if you don't use it all up you lose it and don't get back the difference.

The laws and regulations aren't clear whether valuation is based on equal proportions or actuarial value. If a transfer is considered to be for less than fair market value, only the portion actually paid for at market value will be considered owned by the guyer.

Probably not. If it were done so that the change of title were in exchange for the promise to care for the parent, it could then likely work, though value of the promise to care would have to be determined. Stu

I was actually talking about two different things above. In the first case I was considering a net credit for the whole estate. (I doubt you get it back.) In the second case I was thinking about a per-asset limitation if the value had changed. But the more I think about this the more I believe it can't happen. The value must be fixed at the time of the gift tax return, right? (Ignoring fraud) Otherwise you could have absurd situations when a gifted property has changed hands many times (and/or been developed) between the gift and the death of the giver. It's current value might not even be readily available.

Just to be clear here, what you are calling "work" is what I would call "fail." :) That is, I'm interested in what can go wrong if you intend to use joint tenancy merely to pass the property without probate while still enjoying full basis step up. It would thus be the government arguing that there had been some kind of purchase for consideration. How likely are they to succeed (or even try)? Dan Lanciani ddl@danlan.*com

Fixed at the time of the gift.

Note that gifts made within three years of the date of death are brought back into the estate for estate tax purposes, at full market value at that time.

Well, if the creation of the joint tenancy predated the "consideration" I doubt the IRS would get very far. The joint tenancy was not created "for" or in exchange for the consideration, so it shouldn't qualify as consideration under the statute. Stu

Is there any allowance for improvements made by the donee between time of gift and time of death? What happens if the (whatever) has been sold to a third party by the time of death? Dan Lanciani ddl@danlan.*com

The gift tax credit is not refundable.

Yes, the situation you describe is possible. You get the entire credit based on the gift tax paid. But again it is not refundable. So it is possible to pay gift tax at the time of adding a non-spouse joint owner and then fail to receive full, or any, benefit at death. I do not see this as unfair because the sequence of events is controlled by the taxpayer. The taxpayer decided to add the joint owner as a gift, not the government. This is one reason joint ownership with someone other than your spouse of real estate and some other assets is not always a good probate avoidance technique. The taxpayer can easily avoid this problem with a living trust. snip

The three year rule only applies in limited situations. See Section 2035 which says in part: (a) Inclusion Of Certain Property In Gross Estate.-- If-- (1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or relinquished a power with respect to any property, during the 3-year period ending on the date of the decedent's death, and (2) the value of such property (or an interest therein) would have been included in the decedent's gross estate under section 2036, 2037, 2038, or 2042 if such transferred interest or relinquished power had been retained by the decedent on the date of his death, the value of the gross estate shall include the value of any property (or interest therein) which would have been so included.

----- end quoted text

2036 refers to transfers with retained life estates (the original topic of this thread). 2037 refers to transfers taking effect at death. 2038 refers to revocable transfers. 2042 refers to life insurance. In addition gift tax paid within 3 years of death is also added back to the estate - 2035(b). 2035(c) also includes:

(c) Other Rules Relating To Transfers Within 3 Years Of Death.--

(1) In General.-- For purposes of-- (A) section 303(b) (relating to distributions in redemption of stock to pay death taxes), (B) section 2032A (relating to special valuation of certain farms, etc., real property), and (C) subchapter C of chapter 64 (relating to lien for taxes), 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, by trust or otherwise, during the 3-year period ending on the date of the decedent's death.

----- end quoted text

So as you can see the three year rule is quite limited in application.

If you are still talking about joint property with a non-spouse then the recipient who paid for the improvements will be treated as owner of those improvements. The appraiser will have to take this into account when they do the appraisal. If the property was sold prior to death and each joint tenant gets his or her share at sale then there are typically no further consequences at death. Why? Because the decedent no longer holds any power over the gifted property, assuming Section 2035 doesn't apply.

The statute is vague. The operative language is "if such transferred interest ... had been retained by the decedent...." Those other statutes deal with transfers. But if the decedent had retained an interest the transfer would not have taken place. So really the reference to those other statutes is meaningless.

Do you have any authority for your position? There are no regulations that I could find. And every court case I have looked at talkes about the three-year provision as being generally without the restrictions to which you refer. Stu