by Mike Tucker, CPA
I have created a life estate that gives my house to my child when I die. How will my child determine the tax basis for the property?
I cannot determine your exact status from your question, so I will answer broadly. A life estate can be, and most often is, created as a result of an inter vivos trust arrangement often referred to as an AB type trust. Under this sort of arrangement, both spouses transfer most, if not all, of their property to a living trust. At the death of one spouse, all property placed in the living trust is split into one or the other of the trusts, A or B.
If the primary residence is placed into the A trust, it will be valued at the fair market value (FMV) as of the date of death of the first spouse. This is called a stepped-up basis because the decedentís basis is stepped up to FMV. The surviving spouse is given the use of the residence for the remainder of his or her life but never takes title to the property. The survivor, in this case, is known as the life estate beneficiary.
Upon the passing of the surviving spouse, the property is transferred to the final beneficiary, in this case, your child. Since the property never actually belonged to the life beneficiary, there is no exposure to estate tax liability. On the other hand, there is no step up in basis on the second death.
Therefore, the basis of the property in the hands of your child will be the FMV at the date of death of the first spouse to die.
Alternatively, if the property were placed in the B trust, the surviving spouse has use of the property, but the property will now be subject to estate tax on the death of the surviving spouse. Just as in the above, the other consideration is that the property basis will be stepped up again to FMV on the second death.
Finally, if there is no AB type trust arrangement and you have transferred the property to your child and have retained the right to live in the house for the remainder of your life, then the property is included in your gross estate at FMV at your passing and is subject to estate tax. Your childís basis will be the FMV.
There are many other arrangements which can be made depending on the wishes and needs of the individuals involved. You might want to consult a CPA who provides estate planning to find the most beneficial arrangement.
Mike Tucker is a San Jose, Calif., CPA with the firm of Just, Gurr & Associates. You can reach him at (408) 271-2700.
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