Taxpayers and Homes – Retained Interests and Estate Tax Inclusion Still Alive and Well

By Kathleen Ford Bay  

Richards Rodriguez & Skeith LLP, Austin, TX 

One must wonder where taxpayers are getting the idea that they can deed away ownership of a home, yet continue to live there for years, without having the value of the home (including all of the appreciation since the date of the deeds) included in their estates for federal estate tax purposes.

Two recent Tax Court Memorandum decisions – Estate of Adler v. Comr., T.C. Memo 2011-28, and Estate of Van v. Comr., T.C. Memo 2011-22 – illustrate that the following concepts have not yet been understood and embraced by taxpayers: "retained life estate" and "you can't hold strings to property you once owned without having it included in your taxable estate." In Adler, Mr. Adler had a ranch of approximately 1,100 acres. In 1965 he deeded the ranch to his five children, each to have a  1/5 undivided interest as a tenant in common, subject to a retained interest for life in Mr. Adler.  In 1991, one of the daughters quit claimed her interest back to her father; this deed was never recorded, and, after his death and some litigation, she deeded her interest to her father's estate. 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 of the children owning fractional interests.

The Tax Court determined that "no discount was appropriate;" that is, that the retained life estate made the entire ranch includable in Mr. Adler's estate. Section 2036 of the Code controls and makes the entire value of the ranch includible in the estate. Here, the retained interest was explicitly set forth in the deeds. That is not always the case.

In Van the decedent's ownership of the home and repeated conveyances, resulting in her technically not owning the home at her death, are referred to as title "ducking and weaving throughout her extended family." Van had actually lived in the home since 1973 and purchased the home, with monies from her daughter and son-in-law, in 1989. Although she conveyed title to various family members, then had some of them convey title back to her, and finally conveyed title to her daughter and three grandchildren, she always lived in the home.

The daughter and son-in-law essentially argued that Van had never really owned the home; they claimed ownership of the home as it was their money that was used to buy it – a sort of resulting trust position; but the concept as fashioned by the daughter was determined by the Court as one not supported by California law.  While the Court did shift the burden of proof from the taxpayer to the Commissioner because the taxpayer revealed the existence of the home on the estate tax return, but did not include its value, the Court found that the Commissioner proved that Van retained a life estate and that the home was includible in the estate.

The following cases were cited in support of this conclusion: Estate of Rapelje v. Comr., 73 T.C. 82, 86 (1979), where the decedent transferred his personal residence to his two daughters but continued living there, and the Tax Court held that "[p]ossession or enjoyment of gifted property is retained when there is an express or implied understanding to that effect among the parties at the time of transfer. … The burden is on the petitioner to disprove the existence of any implied agreement or understanding, and that burden is particularly onerous when intrafamily arrangements are involved. …" The fact that the agreement was implied instead of express did not prevent inclusion in the estate.  Also cited were Estate of Disbrow v. Comr., T.C. Memo 2006-34 (decedent made irregular rent payments for less than amount stated in lease agreement; Court determined there was an implied agreement for continued use and home included in estate) and Estate of Trotter v. Comr., T.C. Memo 2001-250 (occupation of condo after title was transferred, accompanied by no payment of rent resulted in condo's inclusion in estate).

 For more information, in BNA's Tax Management Portfolios, see Lischer, 52 T.M., Incomplete Lifetime Transfers: Retained Beneficial Interests Under Sections 2036(a)(1) and 2037,  and in Tax Practice Series, see ¶6200, Pre-Death Transfers — Sections 2035, 2036, 2037 and 2038.