About ten years ago, we moved our land over to our children's names and kept a life estate in the property to protect it from nursing home costs. At the time, the land was only valued at four hundred per acre and we were well under the one million dollar gift. However, since that time, the land has grown to over eight times those costs and we are now over five million dollars in value in the land. Do we have problems we should be concerned about because the land is really in the kid's names, isn't it?
– Life Estate Age Ten
Dear Life Estate:
Many, many people put their property into a life estate years and years ago to protect it from long-term care.
The good news is the property is now protected from attachment for liens by Medicaid – if you should require long-term care and don't have sufficient assets to pay for this care. Medicaid can still attach the income from the farm, but cannot put liens against the land.
If one spouse requires care, and the other spouse does not, things get a little dicey as the spouse outside the home is only allowed about $2,780/month in income from all sources – Social Security, farm rents, or other 'income' sources.
One issue here is under the life estate, you are responsible for the land taxes and you still have to pay the taxes upon the land – and with recent land values rising – this might take a significant bite out of the spouse's income who is not in the home.
The major issue, however, is this.
When you gave the children the deed to the land, this involved a gift of value. Based on your age at the time you gave the gift, it was a percentage of the FMV of the land at the time. Normally this was somewhere between thirty and fifty percent of the value of the land at the time. Not a big deal when land was at four hundred per acre.
The problem comes from this. Too many people went into life estates and did not file the gift tax return for the gift to the children for their interest in the property. This amount would be deducted from the couple's overall gift/estate tax amount of five million two hundred and fifty thousand.
However, if no gift tax return was filed at the time of the life estate transfer, the burden of proof of the value of this gift can be questioned by IRS at the time of your death. With land values going up eight times in value, what are the children going to tell IRS it was worth?
It's not too late to file a gift tax return but it will be a 'late' report – dated for the year of the gift – and based on a value back ten years ago. The good news is IRS has three years to challenge this valuation and if they don't, then the value you put on the return should stand up. As long as the gift didn't exceed one million dollars – the exemption at the time, then no taxes would be due.
The second part of the equation is this – and this is where things are going to be bad for people with life estates.
Property with a life estate designation is still included in your estate for estate tax purposes at it's now current FMV for estate tax purposes. For example, if the land is now valued more than $5,250,000, your kids are going to pay forty-five percent estate taxes on the excess over and above this amount.
Remember also you have to deduct the value of the gift you made – and filed a gift tax return upon from the gift ten years ago – from the $5,250,000 gift/estate tax credit.
The children do not get to deduct this prior gift from the FMV assessment of the property at the time of your death(s) for estate taxes today.
In order to avoid taxation on a joint estate – most life estates are joint tenancy with right of survivor – some people may need to sever the joint life estate interest using tenants in common with their spouse. They can then have their 'life estate' interest pass into trust with the survivor spouse receiving income from said trust until his or her death allowing for both spouses to use their $5,250,000 estate tax credit.
Due to inflation on land, a failure to file gift returns on the prior life estate ownership change and not doing adequate planning, a lot of 'life estate' owners are going to run into some estate tax problems – potentially devastating estate tax consequences.