In this case, the family came to me with the following problems. Their mother had a life estate in both a farm and in some minerals. Both the minerals and the farm had the opportunity to turn into a taxable estate if the values increased.
Fact: Because the mother retained a life estate in both the minerals and in the farmland, the entire value – its total appraised value of both land and minerals – would be included in her estate for estate tax valuation purposes.
Most people assume life estates either are not included in estate tax returns for decedents or the value will not be the ‘full’ market value at the time of death because the life estate owner has gifted away the deed. This is not true. IRS states the ‘full value of any property with a life estate shall be includable for estate tax returns’.
Problems: At the time the remainder interest was gifted to the children and the mother kept a life estate – shortly after the time of their father’s death – the attorney handling the estate had not filed a gift tax return for the estate as he assumed – correctly at the time – the estate would not be a taxable estate. However, as the minerals became active and the farmland quadrupled in value, appraisals now showed the total value of Mom’s estate to be around eight million dollars – far and above the five three hundred and forty thousand now allowed. This would have led to estate taxes on the excess over and above this amount.
Solutions: First of all the property was appraised – both the farmland and the minerals. The appraiser was then asked to give an appraisal dating back four years to when the farmland had been gifted. An appraisal of minerals back four years ago was impossible to attain.
This allowed the clients to determine what gift Mom had made four years ago. IRS does have a formula to follow – based on the appraised value and the age of the grantee (Mom, in this case) – what the value of the gift was to the children back in 2010. At the time, the gift was about forty-five percent of the value of the land.
The clients then submitted a gift tax return for 2010 with these amounts and the appraisal. Because the client was allowed to gift more than the total forty-five percent value of the land was, this was a non-taxable event.
However, this gift did have to be deducted from Mom’s lifetime exemption of five million three hundred and forty thousand dollars. IRS has three years to disagree with the filing of the gift tax return and if not, the value then stands.
Next, the client gifted her life estate value in both the minerals and the land into an LLC. Being as she was still able to discount the entire value of the property by almost fifty percent, using IRS’s life estate/remainder interest tables, and because she was retaining interest in the LLC, we had another non-taxable gift – again which was filed with IRS.
Why inform IRS every step of the way? Because, like this woman, someday your children may have to prove what land was selling for years before when she made the original gift, and when she made the secondary gift to the LLC, and what the value of her remaining stake in the LLC will be at the time of death. Without letting IRS know the value of these gifts – even though they were all non-taxable gifts – we allowed the three-year look back period for IRS to expire and then all the gifts were allowed at the amounts she put on the return. Without this paper trail with IRS, the children would be at sea on a rowboat without a paddle at the time of Mom’s death!
Many people might tell you to go ahead and make gifts and ‘don’t worry about reporting it to IRS because it’s not a taxable gift’ – remember – any gift exceeding the current thirteen thousand dollar per person per year rule must be reported so you have a future paper trail with IRS. This includes gifts of life estates, bequests from estates received from decedents, or any other cash or real property bequests received exceeding this dollar amount. It’s not required by law – but it is smart business.
“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917
Toll Free: 1-800-373-4078