Early Sale Of Life Estate Property

[STEVE1]

About once a year, I have someone who sells a house that is titled as a life estate with a life tenant and several remainder people. This is usually a parent with several children.

Because it is a sale prior to the death of the life tenant , it would seem the remainder owners would have to pay capital gains on their share of the proceeds.

Several years ago, I saw this situation where a preparer had the remainder people pay only a portion of the capital gains based on the Table S factors. The thinking must have been that likely all the gain could have been avoided if the life tenant had died first.

The preparer did a computation based on factors at time of the gift and again at time of the early sale to justify excluding part of the gain.

Unfortunately, I did not save this computation. And the more I think about it, I don't know if there is justification for this or if the preparer was just taking an aggressive position.

Has anyone ever run into this?

[solomon]

At the time of sale - §7520 and Pub 1457. The life tenant portion should fall under §121 exclusion and capital gain for the remaindermen.

[STEVE1]

early sale of life state

Solomon, I agree with you, so let it be said that you truely are a wise person.

[solomon]

Solomon, I agree with you, so let it be said that you truely are a wise person.

If only the truth were known.

[Bees Knees]

Before selling the house, why not have the remainders gift their interest back to the life tenant? Then all the gain can be excluded under Section 121. Then the life tenant can gift the proceeds back to the remainders after the sale. If total gifts fall below the $1 million gift tax lifetime exclusion, there is no gift tax liability. Problem solved.

[solomon]

Didn't think of that - Bees is the wise one.

[New York Enrolled Agent]

Before selling the house, why not have the remainders gift their interest back to the life tenant? Then all the gain can be excluded under Section 121. Then the life tenant can gift the proceeds back to the remainders after the sale. If total gifts fall below the $1 million gift tax lifetime exclusion, there is no gift tax liability. Problem solved.

Do you really think it's that simple? It seems to me that the Supreme Court wording in Duberstein - "A gift in the statutory sense, on the other hand, proceeds from a "detached and disinterested generosity,"" is sadly lacking.

It's possible that this "scheme" might run afoul of the reciprocal trust doctrine. As one example, see Sather TC Memo 1999-309.

[Bees Knees]

It's possible that this "scheme" might run afoul of the reciprocal trust doctrine. As one example, see Sather TC Memo 1999-309.

Sather is an S corporation gift of stock issue. Different set of circumstances.

I'm talking about undoing a gift of a joint tenancy in Dad's house so that Dad can sell the house and take the full exclusion of gain under Section 121. Since the kids paid no money to get their joint tenancy interest in the house, there should be no reason why they can't undo the gift later if Dad decides to sell the house.

In a similar set of circumstances, if Dad were to gift a joint interest in his house to the kids, and then later die, the kids joint interest would turn into inheritance and they get full step up of basis. [TTB page SB10-33]

The reason none of this runs afoul of the reciprocal trust doctrine is because each gift back and forth is subject to gift tax and or estate tax, with the full value being reported on the Dad's estate tax return at death. The price you pay for the kids being able to avoid capital gains tax is an increase in Dad's taxable estate at death.

[solomon]

If this were done correctly in the first place with an Enhanced Life Estate, (given that state's laws permitted this type of deed) there would be no need for the remainder people to gift it back. The life tenant would sell it and take the full exclusion.