Main Menu Name: Split
Calculates the amount each party must pay when property is split between them and one party acquires a life income interest in the assets while the other acquires a remainder interest. It also calculates the amount each party receives upon the sale of the property and the potential income and estate tax savings.
In this article:
In a "split interest" purchase arrangement, an asset is purchased by one party who acquires a life income interest in the asset while the other party acquires a remainder interest. Each party pays his or her proportionate share of the cost based on the IRS tables that state the actuarial value of a life estate and remainder interest at various ages.
An uncle and niece, for example, might agree to acquire land that they feel will appreciate. Assume the land has a value of $100,000. If the uncle is 55 years of age, assuming a Section 7520 rate of 12 percent, his life income interest is worth 86.0 51% ($86,051) of the full value of the property. He will pay that amount toward the split purchase. His niece will contribute the balance of $13,949 as her share of the $100,000 purchase.
If the arrangement is structured properly, the uncle (life tenant) will receive the right to possess the property in question or enjoy any income it produces for as long as he lives. In many cases, this means the life tenant will enjoy more income than he would have received had he invested the amount of his contribution to acquire the same type of asset.
In the example above, the uncle invests $86,051, but if the $100,000 property produces a ten- percent return, he will receive $10,000 a year, which is considerably more than if he had received ten percent of $86,051. Should the income produced by the split purchased asset increase, so will the life tenant's income. If the life tenant outlives the actuarial life expectancy built into the IRS assumptions, he will continue to enjoy the property (or to receive the income it produces). The life tenant is taxed on any income received (unless the asset is a tax-exempt bond, or is otherwise exempt from tax).
If (and only if) the parties to the SPLIT are unrelated, or are beyond the Internal Revenue Code definition of "applicable family members", a number of significant estate tax objectives may be accomplished by the split interest purchase:
- First, assuming the property is fairly valued (at least one independent and highly qualified and diligent appraiser is suggested), there should be no gift tax on the creation of the interest if the government's tables are used to determine the actuarial contributions of each party.
- Second, since the life estate terminates upon the death of the life tenant, there can be no transfer by that individual. Absent a transfer, nothing is subject to the federal estate tax.
- Furthermore, the underlying asset is at that time owned by the remainder person and cannot be part of the probate estate. Therefore, the uncertainty, delay, and cost of probate are eliminated.
If the underlying asset appreciates in value between the time of acquisition and the life tenant's death, any appreciation will also be excluded from the life income owner's estate.
The remainder interest holder receives no advantage during the life tenant's life. The remainderman derives his or her sole benefit upon the death of the life income owner (except for the significant advantage of knowing that no one else can receive the property at the life tenant's death.)
No increase in basis is allowed to the remainderman at the life tenant's death. This is because nothing is in the life tenant's estate and, therefore no part of the property receives a "step up in basis." The remainderman's basis is the cost of his remainder interest. Therefore, upon the sale of the property after the death of the life tenant, the remainderman realizes a gain. That gain is equal to the difference between his basis (the amount paid when the property was purchased) and the amount realized by the remainderman upon the sale.
There are downsides and risks to the split interest purchase. First, if it is between family members, there will be immediate gift tax implications. Second, the IRS may question whether the remainder person did in fact furnish consideration for the acquisition of the remainder interest. Obviously, if a source of income other than the life tenant can be shown, or if that individual has resources of his own with which to make the acquisition and he or she is an adult, the likelihood of IRS success is reduced considerably.
Conversely, if the client provides financing to the remainder person, the IRS could view the transaction as one in which the uncle acquired an interest in the entire property and then made a gift of the remainder interest with the retention of life income. This will result in estate tax inclusion.
Each party should pay the actuarial value of his or her interest, the property should be purchased independently and simultaneously from an unrelated third party who fixed the value of property, and the life tenant's control, rights, and duties should be consistent with those of a life tenant.
To the extent the remainderman does not furnish consideration for the acquisition of his or her interest, the IRS will attempt to show that a gift has been made from the life tenant to that remainderman. Since this would be considered a gift of a "future interest," the annual gift tax exclusion would not be allowable on the gift. Therefore, there would be adverse income, gift and estate tax implications.
Counsel should draw this split interest purchase so it will be recognized under local law as a combination of life tenancy and remainder interest. Title to the asset should be taken in a manner that reflects the appropriate division.
When two parties agree to a split interest purchase arrangement, one party purchases an asset and receives a life interest in the asset while the other party receives a remainder interest in the property. Each party contributes a proportionate share to the cost based on IRS regulations that determine the actuarial value of a life estate and remainder interest.
For example, a uncle and niece purchase land with a value of $100,000. The father is 55; therefore, assuming a Sec. 7520 rate of 12%, his life income interest is equal to 86.052% of the property ($86,052). He will pay that amount toward the split interest, and his niece will contribute the remaining $13,948.
Under the split interest arrangement, the uncle (term tenant) owns the purchased property and retains any income it produces for the remaining years of his life. The uncle will most likely receive more income under this arrangement than he would if he had invested his contribution to purchase the same type of asset. For example, if the $100,000 property produces a 10% return, he will receive $10,000 a year that is more than if he had received 10% of his $86,052 contribution. The life tenant is taxed on any income received.
If the two split interest parties are unrelated or beyond the IRC definition of "applicable family members," several estate tax objectives can be accomplished. First, if government tables are used to determine each party's contributions, no gift tax is incurred on any interest produced.
Additionally, the life estate ends when the life tenant dies; therefore, no transfer can occur. Without a transfer, no federal estate tax is applicable. If the asset appreciates between the time of purchase and the life tenant's death
The remainderman receives no increase in basis when the life tenant' death occurs (the remainderman's basis is the cost of his remainder interest). Instead, the remainderman' gain comes from the sale of the property after the death of the life tenant.
There are drawbacks to the split interest purchase. For example, the transaction may cause immediate gift tax implications (under Code Sec. 2702 of Chapter 14) if it is between family members. Also, the IRS may question whether the remainder man actually provided his part of the purchase. If the remainderman can not produce a source for his share of the purchase (especially if he' not an adult), the IRS may assume the remainder interest was a gift from the life tenant. If the IRS makes this conclusion, estate tax inclusion under IRC 2036 will result.
These problems are avoided if the split interest transaction follows these guidelines:
- The asset title reflects the correct split purchase division.
- Each party provides their appropriate portion.
- Portions are determined using IRS tables valuing life and remainder interest.
- Each party documents the source of the portion paid.
- The transaction is put into writing.
If the parties so choose, they can end the split interest purchase arrangement by selling the asset and dividing the proceeds in accordance with each party's actuarial interest at the time the asset is sold. To determine how much each party receives, enter the life tenant's age and the property value at the time the asset is sold.
- Transfer Date: Enter the month and year. Note: For May or June of 2009, you have the choice of using mortality Table 90CM or 2000CM (see https://www.irs.gov/irb/2009-20_IRB). After June 2009, the program will automatically use Table 2000CM. For dates before May 2009 and after June 1999, the program will use Table 90CM. For May or June of 1999, you have the choice of using Table 80CNSMT or Table 90CM. For dates before May 1999 and after April 1989, the program will automatically use Table 80CNSMT. For dates before May 1989, the program uses Table LN from Treas. Reg. section 20.2031-7A(d)(6).
- §7520 Rate: The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
- Age of Life Tenant (Client): Enter the age of the life tenant (client) at the time the property is purchased (or sold).
- Number of Years Until Sale: Enter the number of years until the property is sold. If you choose to have the program use the life tenant's remaining life expectancy, this entry field will be disabled.
- Use Life Expectancy: Select the check box to use tenant's remaining life expectancy (with the tax table as determined by the Transfer Date.).
- Value of Property: Enter the value of the property at the time it was purchased (or sold).
- After-Tax Growth Rate: Enter the growth rate after the effect of taxes is factored out.
- Assumed Value at Sale: Enter the value you assume the property will have when sold at the life tenant's death. This entry field will not be available if you choose to use the computed value.
- Use Computed Value: Select the check box to use the value calculated by the program (Value of Property grown by the entered After-Tax growth).
- Combined Fed/State Tax Bracket: Enter the combined federal and state tax bracket.
The program shows the amount that each party must contribute in a split interest purchase, or the amount each party receives in a sale of property purchased in a split interest arrangement. The life tenant must provide the amount indicated at Value of Life Interest on the results screen, and the remainder interest holder must provide the amount indicated at Value of Remainder Interest. The results also show the amount of income that will be produced annually (Remainderman's Return on Investment) by the property purchased.