| Estate & Gift Tax / Retained life interests |  |
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Many taxpayers are interested in
giving property away while retaining an interest in it hoping to get the
property out of their estates while keeping some strings attached. Under
the estate tax rules, however, this is a dangerous approach: the entire
value of the property at the time of your death will be included in your
estate. Typically, the situation arises when
the taxpayer transfers ownership of a substantial amount of his assets
to a trust for the benefit of his family but keeps the right to the
income from the trust property for as long as he lives. This arrangement
splits the property interest into the taxpayer's life interest and the
beneficiaries' remainder interests. Valuation tables establish the value
of each interest, based on the age of the taxpayer and a reasonable
interest rate. As for the tax results, first, the
granting of the remainder interest to the beneficiaries is a taxable
gift in the year in which the trust is set up even though they will not
receive the property until the future. It is taxable in its entirety,
but because it is a gift of a future interest, it does not qualify for
the annual gift tax exclusion. Although you will not actually have to
pay any gift tax until your lifetime gifts total more than the exemption
provided by the unified credit ($675,000 in 2000 and 2001, gradually
rising to $1 million in 2006), taxable gifts will use up part (or all)
of this credit, which could have been available for your estate. Second, even though you were treated
as giving away the remainder interest, the entire value of the property
is included in your estate at your death. (To mitigate the tax cost of
this inconsistent treatment, your estate is allowed a credit for any
gift taxes paid during life with respect to the gift.) Retained interests. Note that merely retaining the
right to the income even if you never use that right (i.e., never
receive any income from the property) will cause the property to be
included in your estate. Additionally, if you keep the right
to the income for a designated period of time instead of for life, or
until a specified dollar amount is reached, the property still comes
back into your estate if you in fact die before the period ends or the
amount is reached. For example, if you retain the right to income for
just two years, the property is included in your estate if you die
before the two-year period ends. Similarly, if you retain the right to
the first $15,000 of income from the transferred property, the property
is included in your estate if you die before receiving the entire
$15,000. Even if you do not retain the right
to receive the income yourself, the property may be included in your
estate if you retain powers over it, e.g., the power to designate the
beneficiaries or their interests. Real estate.
The retained interest rules are also commonly triggered when a taxpayer
transfers the ownership of noncash property like a residence to children
or others but retains the right to live in it for life. In this case,
retaining the use or enjoyment of the transferred property for life will
cause the property to be included in the estate in its entirety. Even if
there is no formal agreement granting the taxpayer the right to continue
living in the home, if he in fact continues to do so for life, the IRS
may find an implied right was retained. The three-year rule. If a taxpayer transfers property but retains a life interest, inclusion in the estate can be avoided by his giving up the life interest. However, under a special rule, even if the retained interest is given up, the property will be included in the estate if the transferor dies within three years from the time the interest was given up. |
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