A life estate is a present possessory interest in property whose duration is measured by a life, usually the holder’s own, with the future interest in the same property owned by someone else from the moment the life estate is created. The holder is the life tenant. Two people hold interests in the same property from that moment, and only one of them has possession.
A third party named in the instrument holds a remainder, a future interest that falls in at the natural end of the preceding interest and that has to appear in the same instrument (Legal Information Institute, remainder). A grantor who keeps the future interest instead holds a reversion, and the property comes back to the grantor when the life estate ends (Legal Information Institute, reversion). Where the measuring life is someone other than the possessor, the arrangement is a life estate pur autre vie (Legal Information Institute, life estate).
Why a Retained Life Estate Comes Back Into the Gross Estate
Deeding the property away and keeping the right to live in it does not take the property out of the transferor’s estate. The gross estate includes all property, to the extent of any interest in it, that the decedent transferred at any time, other than in a bona fide sale for an adequate and full consideration in money or money’s worth, where the decedent retained for life, for a period not ascertainable without reference to death, or for a period which does not in fact end before death, either the possession or enjoyment of, or the right to the income from, the property, or the right, alone or with any person, to designate who shall possess or enjoy the property or its income (26 U.S.C. 2036(a)). The section is titled Transfers with retained life estate.
Basis then follows the inclusion rather than the deed, and it can carry a subtraction. Where property acquired from the decedent before the death has to be included in the gross estate under chapter 11 of subtitle B, the basis is the amount determined under section 1014(a) reduced by the amount allowed to that taxpayer as deductions in computing taxable income for exhaustion, wear and tear, obsolescence, amortization and depletion on that property before the death (26 U.S.C. 1014(b)(9)). The rest of the reset is worked through in step-up basis.
Who Takes the Depreciation
The life tenant does, computed as though they owned the property outright. For property held by one person for life with remainder to another, the deduction is computed as if the life tenant were the absolute owner and is allowed to the life tenant; property in trust splits between the income beneficiaries and the trustee under the instrument, or on trust income allocable to each where it is silent; property held by an estate splits between the estate and the heirs, legatees and devisees on income allocable to each (26 U.S.C. 167(d)). Method and recovery period are the ordinary ones, set out in MACRS.
What the life tenant cannot do is write the life interest itself down as it runs out. Amounts paid under state law as income to the holder of a life or terminable interest acquired by gift, bequest or inheritance are not reduced by any deduction for shrinkage, by whatever name called, in the value of that interest due to the lapse of time (26 U.S.C. 273). The wasting is real, and it is not deductible.
A related remainderman can shut the deduction off, which is where a flat reading of the life tenant rule goes wrong. No depreciation or amortization deduction is allowed for a term interest for any period during which the remainder is held, directly or indirectly, by a related person, meaning one bearing a relationship described in subsection (b) or (e) of section 267, and that denial does not reach a term interest to which section 273 applies (26 U.S.C. 167(e)). A term interest means a life interest, an interest for a term of years, or an income interest in a trust (26 U.S.C. 1001(e)(2)).
What Happens When the Life Interest Is Sold
Selling the life interest alone does not let the seller use the portion of basis that came from section 1014, 1015 or 1041. On the sale or other disposition of a term interest, the portion of adjusted basis determined under section 1014, 1015 or 1041 is disregarded, unless the disposition is part of a transaction transferring the entire interest in the property (26 U.S.C. 1001(e)).
How a Life Estate and Its Remainder Are Valued
Actuarially, not by carving the property’s value between the two holders. The value of any annuity, any interest for life or a term of years, and any remainder or reversionary interest is determined under tables prescribed by the Secretary, using an interest rate equal to 120 percent of the federal midterm rate in effect under section 1274(d)(1) for the month in which the valuation date falls, rounded to the nearest two-tenths of 1 percent (26 U.S.C. 7520(a)).
For an estate, the remainder factor comes from Table S at the applicable section 7520 rate and the age of the measuring life, and the life estate factor is that remainder factor subtracted from 1.00000, published in the Life Estate column of the same table (section 20.2031-7(d)(2)(ii)(B) and (d)(2)(iii)). The willing-buyer standard behind the fair market value those factors apply to is set out in valuation.
The regulation publishes its own sample factors from Table S, based on Table 2010CM, for an individual aged 75 at a section 7520 rate of 3.2 percent: 0.30097 for the life estate and 0.69903 for the remainder (section 20.2031-7(d)(2)(iv)(B)). Applied to an appraised value, the two interests take the whole property between them.
Appraised value of the property 400,000
Life estate 400,000 x 0.30097 120,388
Remainder 400,000 x 0.69903 279,612
Total 400,000A Life Estate Is Not a Trust, and It Is Not the Deed
The life tenant holds a present interest in the property itself. A trust, as the regulations define the term for Code purposes, is an arrangement created by a will or an inter vivos declaration whereby trustees take title to property to protect or conserve it for the beneficiaries under the ordinary rules applied in chancery or probate courts (section 301.7701-4(a)). The trustee takes title there, which is the reverse of where the life tenant stands.
The interest is also not the instrument that creates it. A life estate is created by a deed giving the property to a person for life and identifying what should happen to it after that person dies (Legal Information Institute, life estate), and the Code contemplates a life interest acquired instead by gift, bequest or inheritance (26 U.S.C. 273), so a will or a trust instrument can create one too. A transfer at death of the property itself, rather than of a life interest in it, is a bequest.
Common Questions
It means the holder may use and possess the property, and may transfer that interest during their lifetime, but cannot leave the property to anyone in a will, and a third party who takes the interest has to surrender it to the remainderman once the measuring life ends (Legal Information Institute, life estate).
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