Don't Forget About the Gift Tax
A real estate lawyer friend of mine contacted me earlier this week and posed a series of questions for me regarding a proposed transaction with one of his clients, who he has referred to me for estate planning. We are in the process of designing this client's estate plan, but have not completed any of the actions that will be appropriate for him. The proposed transaction involved the client's long time live-in companion. The client and his girlfriend are not yet married because we are working on the terms of a premarital agreement acceptable to both parties.
The transaction that was at issue involved recent travel by the client. The client had contacted the real estate lawyer to determine what temporary measure could be put in place to allow his fiance to continue to live in his home for as long as she wanted, should he die during this period of international travel.
In Florida, if a person owns a homestead, and is married, the surviving spouse has the Constitutional right to a life estate in the homestead regardless of the manner in which the homestead is titled at the time of the owner's death. That means the surviving spouse can live in the home for his or her lifetime, so long as the homestead is properly maintained, property taxes are paid, mortgage payments are made if there is a mortgage, and the homestead is maintained properly. So, in this case, if the client and his fiance were already married, there would have been no action necessary to protect her right to remain in the homestead should the client expire while out of the country. But, they are not married, and he wanted to protect her right to live there from his legal heirs - his children from a previous marriage in this instance. Certainly, not an uncommon situation in today's mobile society.
The real estate lawyer's proposed solution was a practically efficient one, but as we'll see did not consider several very important considerations that are not involved with the typical real estate transaction. The real estate lawyer suggested that he prepare a deed to be signed by the client, that would transfer to the fiance a life estate in the home that would allow her to live there for her remaining life, and at her death the title to the homestead would transfer to his adult children. The real estate lawyer further proposed that the client would deliver the deed to the real estate lawyer for "holding" pending the client's return from his travels. If the client died during the trip, the real estate lawyer would record the deed transferring the life estate to the fiance in the public records. If the client returned safely from his travels, then the deed would be returned to him and it could be destroyed. The real estate attorney also proposed that the client retain the right, in the deed, to transfer, convey or mortgage the property during his lifetime, so that if the deed was recorded in the public records the client would retain the right to "control" the property during his lifetime.
My real estate attorney friend wanted to know if the proposed transaction would be satisfactory and coordinate with the estate planning that I was putting in place for the client. This conversation was taking place two weeks after the travel was concluded, after the deed was prepared and delivered to the real estate attorney, and, fortunately, the deed was not recorded in the public records.
I explained to my real estate lawyer friend that there were a number of problem with the proposed (aborted) transaction. First, I pointed out a number of potential issues involving the transaction that involved titling to homestead, whether the proposed deed was an effective enhanced life estate deed, issues involving the effectiveness of the deed, and the effectiveness of the conditional delivery of the deed for recording in the event of the client's death during his travels, and a number of other issues surrounding title to the property.
Then, from a purely estate planning perspective, I explained to my friend that there had been no consideration of the potential estate and gift tax issues created by the proposed transaction. The transfer of a life estate to his fiance, with the remainder interest at her death to his children, for no consideration flowing from the fiance and children to the client, is a gift. Pursuant to the provisions of the gift tax sections of the Internal Revenue Code, the transfer of an interest in property for no consideration triggers a transfer tax. If the transfer is made during the donor's (the person making the gift) lifetime, the transfer tax is a "gift" tax. If the transfer is made at death, the transfer tax is the "estate" tax, sometimes euphemistically called the "death" tax.
The Internal Revenue Code provides that there is an annual exclusion to the gift tax, that currently allows everyone to "gift" up to $13,000 of value to any other person in any given year without the requirement for filing a gift tax return, or paying any gift tax. However, if a gift is made to another person the value of which is more than $13,000 in a given year, then the donor is obligated, pursuant to the Internal Revenue Code, to file a gift tax return (IRS Form 709). There may be certain exemptions (each person has a $1,000,000 life time exemption for gifts above the $13,000 exclusion) available for a taxpayer that defer, or eliminate, the gift tax liability, but if none of those exemptions are available the gift tax is imposed on the value of the gift in excess of $13,000 made to each donee (the person receiving the gift). The donor has the obligation to pay the gift tax liability, if the gift does not fall within the annual exclusion amount ($13,000) and the donor has no remaining exemption amount ($1,000,000 lifetime). Even if the person making the gift has some of the lifetime exemption remaining, a gift tax return (the IRS Form 709) is required by law to be filed with the IRS in the year following the making of the gift, and any remaining exemption must be applied until the exemption is exhausted.
The bottom line is, if you make a gift to one person that is valued at more than $13,000 in a given year (all gifts to that individual made during the year must be totaled), then you are obligated by the Internal Revenue Code to file a gift tax return. You may or may not have gift tax liability, but you are required to file the return even if you don't have any gift tax liability.
So, the client who signed the deed transferring a life estate to his fiance, with the remainder interest to his sons, has made a gift. The value of the gift is divided into two parts: the life estate to the fiance, and the remainder interest to the sons. The calculation of the value of the life estate is prescribed by the Internal Revenue Code and depends on current interest rates and the remaining life expectancy of the fiance (in this case she is 40 years old - so has a fairly lengthy life expectancy). The value of the gift to the client's children is determined by discounting the future value of the remainder interest in the property, and discounting it to present value (a calculation required by the Internal Revenue Code).
In this case, the value of both the life estate and the remainder interest is the value of the property. The current fair market value of the client's home is $1.8 million. The real estate lawyer's solution, created a gift of $1.8 million, triggering the requirement that the client file a gift tax return. This client has an estate subject to the federal estate tax, so the transfer if fully taxable. The current gift tax rate is 45%. The gift tax liability for this "temporary" solution to providing the fiance with the security of knowing she would be able to live in the home should the client die while traveling is approximately $800,000. Fairly expensive trip!!
If the parties ultimately execute a premarital agreement that allows the fiance, upon becoming his spouse, to have a life estate in the home, with the remainder interest to the client's children, or otherwise provide for the children and allow the homestead to go to the wife, the $800,000 transfer tax can be eliminated. The client could also have used a revocable living trust, to which he could have transferred the homestead without creating a gift, and then could have provided in the trust that his fiance could reside in the home for whatever period of time was desired, the transfer of the homestead to the revocable trust - because it is revocable - would have eliminated the potential tax liability and avoided the necessity for filing a gift tax return.
There are other negative consequences to the real estate lawyer's solution, including the potential elimination of the Florida homestead exemption from property taxes, as well as creditor protection, lost of "stepped up" basis that will result in higher capital gains taxes upon the ultimate disposition of the homestead by the children, and others as well.
The moral of this story is that anytime there is a transfer of an asset that has a value in excess of $13,000, for less than fair market consideration, the transferor of the property should consider the potential gift and estate tax consequences of the transfer, as well as the income tax consequences, along with the legal requirements necessary to effect the transfer. In that context, it is important to remember, that just like all other professions in today's complex society, different lawyers have different expertise. The real estate lawyer may or may not be experienced in estate and gift tax, or even income tax, matters. The complexity of the tax code, and its application to common transactions, is not always apparent. Whenever contemplating a transfer of a valuable asset, consider consulting with an experienced estate and gift tax attorney to be sure you are not creating tax liabilities unnecessarily. Protect your assets from unnecessary taxation!
The transaction that was at issue involved recent travel by the client. The client had contacted the real estate lawyer to determine what temporary measure could be put in place to allow his fiance to continue to live in his home for as long as she wanted, should he die during this period of international travel.
In Florida, if a person owns a homestead, and is married, the surviving spouse has the Constitutional right to a life estate in the homestead regardless of the manner in which the homestead is titled at the time of the owner's death. That means the surviving spouse can live in the home for his or her lifetime, so long as the homestead is properly maintained, property taxes are paid, mortgage payments are made if there is a mortgage, and the homestead is maintained properly. So, in this case, if the client and his fiance were already married, there would have been no action necessary to protect her right to remain in the homestead should the client expire while out of the country. But, they are not married, and he wanted to protect her right to live there from his legal heirs - his children from a previous marriage in this instance. Certainly, not an uncommon situation in today's mobile society.
The real estate lawyer's proposed solution was a practically efficient one, but as we'll see did not consider several very important considerations that are not involved with the typical real estate transaction. The real estate lawyer suggested that he prepare a deed to be signed by the client, that would transfer to the fiance a life estate in the home that would allow her to live there for her remaining life, and at her death the title to the homestead would transfer to his adult children. The real estate lawyer further proposed that the client would deliver the deed to the real estate lawyer for "holding" pending the client's return from his travels. If the client died during the trip, the real estate lawyer would record the deed transferring the life estate to the fiance in the public records. If the client returned safely from his travels, then the deed would be returned to him and it could be destroyed. The real estate attorney also proposed that the client retain the right, in the deed, to transfer, convey or mortgage the property during his lifetime, so that if the deed was recorded in the public records the client would retain the right to "control" the property during his lifetime.
My real estate attorney friend wanted to know if the proposed transaction would be satisfactory and coordinate with the estate planning that I was putting in place for the client. This conversation was taking place two weeks after the travel was concluded, after the deed was prepared and delivered to the real estate attorney, and, fortunately, the deed was not recorded in the public records.
I explained to my real estate lawyer friend that there were a number of problem with the proposed (aborted) transaction. First, I pointed out a number of potential issues involving the transaction that involved titling to homestead, whether the proposed deed was an effective enhanced life estate deed, issues involving the effectiveness of the deed, and the effectiveness of the conditional delivery of the deed for recording in the event of the client's death during his travels, and a number of other issues surrounding title to the property.
Then, from a purely estate planning perspective, I explained to my friend that there had been no consideration of the potential estate and gift tax issues created by the proposed transaction. The transfer of a life estate to his fiance, with the remainder interest at her death to his children, for no consideration flowing from the fiance and children to the client, is a gift. Pursuant to the provisions of the gift tax sections of the Internal Revenue Code, the transfer of an interest in property for no consideration triggers a transfer tax. If the transfer is made during the donor's (the person making the gift) lifetime, the transfer tax is a "gift" tax. If the transfer is made at death, the transfer tax is the "estate" tax, sometimes euphemistically called the "death" tax.
The Internal Revenue Code provides that there is an annual exclusion to the gift tax, that currently allows everyone to "gift" up to $13,000 of value to any other person in any given year without the requirement for filing a gift tax return, or paying any gift tax. However, if a gift is made to another person the value of which is more than $13,000 in a given year, then the donor is obligated, pursuant to the Internal Revenue Code, to file a gift tax return (IRS Form 709). There may be certain exemptions (each person has a $1,000,000 life time exemption for gifts above the $13,000 exclusion) available for a taxpayer that defer, or eliminate, the gift tax liability, but if none of those exemptions are available the gift tax is imposed on the value of the gift in excess of $13,000 made to each donee (the person receiving the gift). The donor has the obligation to pay the gift tax liability, if the gift does not fall within the annual exclusion amount ($13,000) and the donor has no remaining exemption amount ($1,000,000 lifetime). Even if the person making the gift has some of the lifetime exemption remaining, a gift tax return (the IRS Form 709) is required by law to be filed with the IRS in the year following the making of the gift, and any remaining exemption must be applied until the exemption is exhausted.
The bottom line is, if you make a gift to one person that is valued at more than $13,000 in a given year (all gifts to that individual made during the year must be totaled), then you are obligated by the Internal Revenue Code to file a gift tax return. You may or may not have gift tax liability, but you are required to file the return even if you don't have any gift tax liability.
So, the client who signed the deed transferring a life estate to his fiance, with the remainder interest to his sons, has made a gift. The value of the gift is divided into two parts: the life estate to the fiance, and the remainder interest to the sons. The calculation of the value of the life estate is prescribed by the Internal Revenue Code and depends on current interest rates and the remaining life expectancy of the fiance (in this case she is 40 years old - so has a fairly lengthy life expectancy). The value of the gift to the client's children is determined by discounting the future value of the remainder interest in the property, and discounting it to present value (a calculation required by the Internal Revenue Code).
In this case, the value of both the life estate and the remainder interest is the value of the property. The current fair market value of the client's home is $1.8 million. The real estate lawyer's solution, created a gift of $1.8 million, triggering the requirement that the client file a gift tax return. This client has an estate subject to the federal estate tax, so the transfer if fully taxable. The current gift tax rate is 45%. The gift tax liability for this "temporary" solution to providing the fiance with the security of knowing she would be able to live in the home should the client die while traveling is approximately $800,000. Fairly expensive trip!!
If the parties ultimately execute a premarital agreement that allows the fiance, upon becoming his spouse, to have a life estate in the home, with the remainder interest to the client's children, or otherwise provide for the children and allow the homestead to go to the wife, the $800,000 transfer tax can be eliminated. The client could also have used a revocable living trust, to which he could have transferred the homestead without creating a gift, and then could have provided in the trust that his fiance could reside in the home for whatever period of time was desired, the transfer of the homestead to the revocable trust - because it is revocable - would have eliminated the potential tax liability and avoided the necessity for filing a gift tax return.
There are other negative consequences to the real estate lawyer's solution, including the potential elimination of the Florida homestead exemption from property taxes, as well as creditor protection, lost of "stepped up" basis that will result in higher capital gains taxes upon the ultimate disposition of the homestead by the children, and others as well.
The moral of this story is that anytime there is a transfer of an asset that has a value in excess of $13,000, for less than fair market consideration, the transferor of the property should consider the potential gift and estate tax consequences of the transfer, as well as the income tax consequences, along with the legal requirements necessary to effect the transfer. In that context, it is important to remember, that just like all other professions in today's complex society, different lawyers have different expertise. The real estate lawyer may or may not be experienced in estate and gift tax, or even income tax, matters. The complexity of the tax code, and its application to common transactions, is not always apparent. Whenever contemplating a transfer of a valuable asset, consider consulting with an experienced estate and gift tax attorney to be sure you are not creating tax liabilities unnecessarily. Protect your assets from unnecessary taxation!
Posted by Randy Coleman at 10/15/2009 6:08 AM 
Categories: Life Estates,Exemption Planning,Gift Tax,Estate Planning,Titling of Assets,Estate Taxes
Tags: exempt assets lady bird deed gift tax living trusts titling of assets estate planning life estate revocable living trust estate tax enhanced life estate deed Florida homestead exemption
Categories: Life Estates,Exemption Planning,Gift Tax,Estate Planning,Titling of Assets,Estate Taxes
Tags: exempt assets lady bird deed gift tax living trusts titling of assets estate planning life estate revocable living trust estate tax enhanced life estate deed Florida homestead exemption
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