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Unintended Consequences: How Using a Life Estate Results in Gift Tax Liability

- AlerStallings

Using a life estate to transfer a house or other real property has been a planning technique used by many seniors.  But what exactly is a life estate?  Simply put, a life estate is a legal arrangement to transfer property upon a person’s death.  One person (typically the giver) retains or is given an interest in the property for their lifetime.  This person is called a life tenant.  When the life tenant passes away the property passes automatically to the designated recipients, the remaindermen.


Many people who use this tool do so because it is quick and easy.  In reality, what they are doing may result in a variety of unintended consequences.  One of those consequences is that the person creating a life estate may unknowingly exceed their annual gift tax exemption.


When you create a life estate in property you usually retain the ability to use the property for your life.  The remaindermen don’t receive any actual benefit from the property until your passing.

Logic would seem to indicate that the remainder interest in the property would only be equal to some portion of the total value of the property.  Sadly, as is often the case with the IRS logic isn’t controlling in this instance.  Rather, the IRS taxes the giver of a life estate for the entire value of the transfer under § 2702 of the Internal Revenue Code.  While this section of the code seems only to apply to transfer of property via trust, there is a clarification that “The transfer of an interest in property with respect to which there is 1 or more term interests shall be treated as a transfer of an interest in a trust.”

What exactly does this mean?  Well, here’s an example:


Grandma, a widow, lives in a nice home on several acres of land.  Grandma’s home, according to the Auditor, is worth $300,000.  After talking to her neighbor (instead of an estate planning and elder law attorney), Grandma decides to set up a life estate.  Grandma deeds her house to her son, Bill, reserving a life estate for herself.  She intends for Bill to get the house at her passing, wants to avoid probate and only wants the ability to live in the house for as long as she lives.  What mistake has grandma made? Grandma, unknowingly, has greatly exceeded her gift tax exemption.  Under the current law, Grandma is allowed to give Bill up to $15,000 in any given year.  Grandma has exceeded her exemption by $285,000.  As a result, Grandma is now required to file a gift tax return, and, depending on what other gifting she has done, may owe gift tax to the IRS.

Had Grandma consulted with an attorney, she could have used a number of other vehicles to accomplish her goals without incurring any negative tax implications.  For example, if she had met with an attorney at AlerStallings, she may have been able to protect her house using a Trust.




If you or a friend or family member has any questions about Life Estates or the alternative methods that can be used to protect your home, don’t hesitate to contact AlerStallings.  Even if you have already created a life estate, it’s never too late, to look into the alternatives.  An attorney at AlerStallings will gladly meet with you to discuss what planning has already been done and how best to move forward.

“A Lifetime Accumulating Wealth,  An Afternoon Preserving It.”


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