Step up with no Reserved Life Estate

With the key goal of transferring a house to the kids to risk losing its value to long term care costs, a typical method is to transfer the home, but reserve a life estate.

For example, a house built or bought in 1952 for $10,000 and now worth, say $250,000, the appreciation of $240,000 will avoid being treated as a capital gain on sale if the home was includable in the person’s gross estate for federal estate purposes. There is no gain because IRC Section 1014 permits a “step-up” in basis at date of death.

The common method to transfer the home is to reserve a life estate: give the home to the kid but reserve the right for the parents to live there for life. IRC Section 2036 allows that “the gross estate shall include the value of all property…of which the decedent has at any time made a transfer…under which he has retained for his life…the possession or enjoyment, or the right to the income from, the property.” That is, if the parents (in the above example) deed the home to the kids and reserve the life estate, the full FMV is includable in the parents’ gross federal taxable estate and the kids receive the desired step-up in basis.

But what happens if the parents transfer the house but do not reserve the life estate. The black-and-white text of IRC Section 2036 appears to save the day. Here’s why:

Estate of Linderme V. Comm’r, 52 TC 305, a 1969 tax court case found that a right can be retained even though it was not specifically reserved. In the case of a house, if the parents continued occupancy, perhaps continued to pay the real estate tax and expenses, all without paying fair rent to the new owners (the kids), then the parents appear to have retained the life estate even though they did not specifically reserve that particular legal right.

The information contained in this electronic message is intended only for information and discussion and is not intended as legal advice. Note further, I am not your lawyer unless you have paid me money.