Think you can give away ownership in a home and continue to live there without the value of the home being included in your estate? Think again…

Authored by: Neeli Shah

In two recent Tax Court cases, the Tax Court agreed with the IRS and included the decedents’ interest in certain real property (that the decedents thought they had transferred during life) in their respective gross estates.  This illustrates that taxpayers have not fully understood and embraced the concept that “you cannot hold strings to property you once owned without having it included in your taxable estate.”

In Estate of Adler v. Comm’r, T.C. Memo 2011-28 (Jan 31, 2011) the Tax Court agreed with the IRS and not only included the entire value of Mr. Adler’s ranch in his gross estate, but also eliminated the fractional interest discounts claimed on the value of the ranch.

Adler had a ranch of approximately 1,100 acres. In 1965 he deeded one-fifth (1/5) undivided interests in the ranch to each of his five children, as tenants in common.  However, in the deed, he reserved for himself the full use, control, income and possession of the property. After making the gift, Adler continued to live on the property and paid all expenses. None of the children resided there or interfered with his use in any way. In 1991, one of the daughters quit-claimed her interest back to her father.  So at the time of his death, on June 20, 2004, Adler owned a one-fifth interest in the property and his other four children owned the remaining four-fifths.

The executors of Adler’s estate included a one-fifth interest in the ranch, subject to a 32 percent marketability discount and a 16 percent minority interest discount, in Adler’s gross estate.  The executors also reported the value of the other four-fifths interest as transfers made during decedent’s life and each separate one-fifth interest was subject to a 22 percent marketability discount and 16 percent minority interest discount.  The IRS and the family agreed that the value of the ranch at the father’s death was $6,390,000.  However, the family believed that there should be discounts based on four children owning fractional interests.

The Tax Court held that IRC Section 2036 (which includes the value of property transferred by a decedent who retains the possession or enjoyment of or the right to the income from such property in the decedent’s gross estate) treats a transfer of property subject to a decedent’s right to possession or enjoyment as actually occurring at death, not during life. As a result, the Tax Court held that (1) Adler was to be treated as if he had retained the entire interest in the ranch for his life and transferred the four one-fifth interests to his four children at his death, and (2) 100 percent of the value of the children’s interests and his interest were includible in Adler’s gross estate, without any valuation discounts.

Even though it may seem strange in practice, from a tax perspective, the Adler estate would have been better served had Adler, after transferring the fractional interests, given up control of the ranch and paid rent to his children. Rent payments to your children or other transferees is another way to transfer money out of your estate.  Keep in mind, however, the transferee will be subject to income tax on the rental income.

In Estate of Adelina Cheng Van et al. v. Comm’r, T.C. Memo. 2011-22 (26 Jan 2011), the Tax Court determined that the decedent’s principal residence was includable in her estate, even though she purchased it using funds from her daughter and son-in-law and had previously deeded the property to her daughter.

In 1988 Adelina Cheng Van (“Van”) arranged to purchase a house for her daughter Norma and her husband James Hu with money provided to Van by the Hus.  Immediately after taking title, Van deeded the house in joint tenancy to herself and her two grandchildren. In 1994, the grandchildren deeded their interest back to Van. In 1997 Van transferred the house into a revocable living trust.  Finally, in 1999 Van deeded the house to Norma and her granddaughters, but continued to live in the house until her death on May 1, 2000.

Van’s estate did not report the house as an estate asset. The IRS issued a deficiency and noted that because Van lived in the house until her death, there was inclusion in the estate under the “possession and enjoyment” principle of Sec. 2036(a).  The estate noted that the funds for the home were provided by James and Norma Hu and the house was actually owned by the Hus.  The estate also claimed that Van was merely a real estate agent for the Hus.  However, the court ruled that she took legal title under California law and lived in the house from 1973 until her death in 2000. Therefore, she held a beneficial interest in the house for life.  The Hus next claimed that there should be a resulting trust. Van received the funds from the Hus and acted as their agent. However, in the case of a parent-child relationship the assumption is gift rather than agency. Therefore, there was no resulting trust.

In this case, the determinative factor for the estate was Van’s retention of possession of the house. Here, as in the Adler case, inclusion of the house in Van’s gross estate could have been avoided if Van had transferred title and retained no right to possess or enjoy the house without paying rent to the Hus.  Also, in this specific case, inclusion could have been avoided in the first instance had the house originally been deeded to the Hus and never been titled in Van’s name.

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