Life estate with rental income

[dhawkcpa]

Client bought his mother's home and mom has a life estate. On the property there is a cabin which mom has rented out for years. Mom gets the income & pays all the expenses. Can the income be reported on either return? Mom's accountant wants the son to claim it. The son wants his mom to continue claiming it.

Thanks for your thoughts, Dennis

[Burke]

According to your post, not clear whether client bought the Mother's home only -- or all the property? Then this was not a gift. How does the life estate read? Probably use and possession of home only. However, if son now owns the rental cabin (purchased arms length for FMV?) then he claims income and depreciation. Any elaboration on circumstances?

[dhawkcpa]

Client bought everything, house, land & cabin. Client says that mom has the right to rent. Mom does pocket the rent income. I think the rent could go on client's return since he is the owner or on her return since she kept the rent and paid all the expenses. Of course, you can't depreciate what you don't own. Thanks.

[Gary2]

Client bought everything, house, land & cabin. Client says that mom has the right to rent.

These can't both be true. If client bought everything, then mom has no rights. If mom has the right to receive the rent, the client didn't buy the right to the rent, so the question is what exactly did he buy?

Presumably, he only bought the remainder interest. Although this is often described as "he bought the entire house but mom kept a life estate", but it really means that they both have an ownership interest, just not simultaneously. It makes sense that mom, as the life tenant, has the right to do whatever she wants with the property, including leasing it out to someone else and collecting the rent, as long as she doesn't do anything to devalue the property (or something she has no right to, such as selling the entire house to a third party). Client's only rights are to protect their future interest - make sure it doesn't burn down, that the insurance and taxes are paid, etc. Plus, since there appears to be both a cabin and a main home, it's not clear whether the life estate is for the entire property or just the home. However, I'm not a lawyer, I haven't seen the deed, etc., etc. A quick call to the attorney who did the deed should clear that up.

Then the hard part begins. I don't recall whether mom has a capital gain now due to the sale, but I'm pretty sure that if she does, then she can't use the $250K exclusion. So she may have some capital gains tax to pay. I know that if they were to sell this at a future date, then mom's share and client's share of the proceeds would be determined by IRS actuarial tables (not Social Security or Medicaid tables), and it's non-trivial. But I have no idea how to calculate the basis for depreciation now.

[New York Enrolled Agent]

Presumably, he only bought the remainder interest. Although this is often described as "he bought the entire house but mom kept a life estate", but it really means that they both have an ownership interest, just not simultaneously. It makes sense that mom, as the life tenant, has the right to do whatever she wants with the property, including leasing it out to someone else and collecting the rent, as long as she doesn't do anything to devalue the property (or something she has no right to, such as selling the entire house to a third party). Client's only rights are to protect their future interest - make sure it doesn't burn down, that the insurance and taxes are paid, etc. .

Then the hard part begins. I don't recall whether mom has a capital gain now due to the sale, but I'm pretty sure that if she does, then she can't use the $250K exclusion. So she may have some capital gains tax to pay.

But I have no idea how to calculate the basis for depreciation now.

Unless there are some unknown facts not presented here, I agree that only the life tenant claims the rental income and the expenses. The son has a remainderman interest with future ownership rights.

I believe Rev Ruling 84-43 gives the authority for mom (the life tenant) to claim the applicable exclusion (up to $250K) if the property is sold while she is alive. This assumes the 2 out of 5 rule is satisfied. The Rev Ruling was written when the "over 55 and $125K exlcusion" was the law but I see no reason that the change to the current law would result in a different conclusion.

§167(d) states that depreciation should be deducted as if the life tenant was the absolute owner of the property and the deduction shall be allowed to the life tenant.

[Burke]

If it were me, before I got into this, I would want to see a copy of the contract of sale and the life estate as written. I agree with NYEA that she would be able to use the $250K exclusion on an outright sale of the house, but she would not be able to use it on the rental cabin since it is not her primary residence. The gain, if any, would have to be allocated between 121 and a 4797 sale of a business property. This taxable event would occur if she retained a life estate and they were subsequently sold to another party during her lifetime. If sold after she dies and her life estate expires, remainderman son gets stepped-up basis. OP did not specify whether this "purchase" was for less than FMV. But if life estate reads that mother retains the right to income from the cabin rental property for her lifetime, then she does have a life estate interest in that property, and I agree also that 167(d) would apply.