Split Interest

[Kathleen Reynolds]

#2478

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Calculates the amount each party must pay when property is split between them and one party acquires a life income interest in the assets while the other acquires a remainder interest. It also calculates the amount each party receives upon the sale of the property and the potential income and estate tax savings.

When two parties agree to a split interest purchase arrangement, one party purchases an asset and receives a life interest in the asset while the other partyreceives a remainder interest in the property. Each party contributes a proportionate share to the cost based on IRS regulations that determine the actuarial value of a life estate and remainder interest.

For example, an uncle and niece purchase land with a value of $100,000. The uncle is 55; therefore, assuming a Sec. 7520 rate of 12%, his life income interest is equal to 86.052% of the property ($86,052). He will pay that amount toward the split interest, and his niece will contribute the remaining $13,948.

Under the split interest arrangement, the uncle (term tenant) owns the purchased property and retains any income it produces for the remaining years of his life. The uncle will most likely receive more income under this arrangement than he would if he had invested his contribution to purchase the same type of asset. For example, if the $100,000 property produces a 10% return, he will receive $10,000 a year that is more than if he had received 10% of his $86,052 contribution. The life tenant is taxed on any income received.

If the two split interest parties are unrelated or beyond the IRC definition of “applicable family members,” several estate tax objectives can be accomplished. First, if government tables are used to determine each party’s contributions, no gift tax is incurred on any interest produced.

Additionally, the life estate ends when the life tenant dies; therefore, no transfer can occur. Without a transfer, no federal estate tax is applicable. If the asset appreciates between the time of purchase and the life tenant’s death.

The remainderman receives no increase in basis when the life tenant’ death occurs (the remainderman’s basis is the cost of his remainder interest). Instead, the remainderman’ gain comes from the sale of the property after the death of the life tenant.

There are drawbacks to the split interest purchase. For example, the transaction may cause immediate gift tax implications (under Code Sec. 2702 of Chapter 14) if it is between family members. Also, the IRS may question whether theremainderman actually provided his part of the purchase. If the remainderman can not produce a source for his share of the purchase (especially if he’ not an adult), the IRS may assume the remainder interest was a gift from the life tenant. If the IRS makes this conclusion, estate tax inclusion under IRC 2036 will result.

These problems are avoided if the split interest transaction follows these guidelines:

• The asset title reflects the correct split purchase division.
• Each party provides their appropriate portion.
• Portions are determined using IRS tables valuing life and remainderinterest.
• Each party documents the source of the portion paid.
• The transaction is put into writing.

If the parties so choose, they can end the split interest purchase arrangement by selling the asset and dividing the proceeds in accordance with each party’s actuarial interest at the time the asset is sold. To determine how much each party receives, enter the life tenant’s age and the property value at the time the asset is sold.

Entering Data

1. Transfer Date: Enter the month and year. See Transition Period Notes below.
2. §7520 Rate The program automatically enters the correct §7520 discount rate if you have kept the AFR Rates Manager up-to-date. If the AFR Rates Manager is not up-to-date, the program shows a 30% value for the selected transfer date. The program automatically rounds the rate to the nearest 2/10 of 1% as required under §7520.
3. Age of Life Tenant (Client) Enter the age of the life tenant (client) at the time the property is purchased (or sold).
4. Number of Years Until Sale Enter the number of years until the property is sold. If you choose to have the program use the life tenant’s remaining life expectancy, this entry field will be disabled.
5. Use Life Expectancy Select the check box to use tenant’s remaining life expectancy (with the tax table as determined by the Transfer Date.).
6. Value of Property Enter the value of the property at the time it was purchased (or sold).
7. After-Tax Growth Rate Enter the growth rate after the effect of taxes is factored out.
8. Assumed Value at Sale Enter the value you assume the property will have when sold at the life tenant’s death. This entry field will not be available if you choose to use the computed value.
9. Use Computed Value Select the check box to use the value calculated by the program (Value of Property grown by the entered After-Tax growth).
10. Combined Fed/State Tax Bracket Enter the combined federal and state tax bracket.

Results

The program shows the amount that each party must contribute in a split interest purchase, or the amount each party receives in a sale of property purchased in a split interest arrangement. The life tenant must provide the amount indicated at Value of Life Interest on the results screen, and the remainder interest holder must provide the amount indicated at Value of Remainder Interest. The results also show the amount of income that will be produced annually (Remainderman’s Return on Investment) by the property purchased.

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IMPORTANT NOTE: Mortality table 2010CM was included in version 2022.20 of the software. Table 2010CM reflects longer life expectancies than table 2000CM, and will generally result in life interests worth more, while remainder interests worth less. Once finalized, the new 2010CM table will go in effect on the first day of the first month after regulations have been finalized. If you have a prior version of the software, its advised to update to the latest version before the transition period ends (see below).

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Mortality Table Transition Periods

For Transfer Dates On or After 1/1/2021: The regulations provide certain rules to facilitate the transition to the new actuarial tables. For gift tax purposes, if the date of a transfer is on or after January 1, 2021, and before the applicability date of the Treasury decision adopting these regulations as final regulations, the donor may choose to determine the value of the gift (and/or any applicable charitable deduction) under tables based on either Table 2000CM or Table 2010CM. Similarly, for estate tax purposes, if the decedent dies on or after January 1, 2021, and before the applicability date of the Treasury decision adopting these regulations as final regulations, the value of any interest (and/or any applicable charitable deduction) may be determined in the discretion of the decedent’s executor under tables based on either Table 2000CM or Table 2010CM, provided that the decedent’s executor must use the same mortality table to value all interests in the same property. However, the section 7520 interest rate to be utilized is the appropriate rate for the month in which the valuation date occurs, subject to the following special rule for certain charitable transfers. Specifically, in accordance with this transitional rule and the rules contained in §§1.7520-2(a)(2), 20.7520-2(a)(2), and 25.7520-2(a)(2), in cases involving a charitable deduction, if the valuation date occurs on or after January 1, 2021, but before the applicability date of the Treasury decision adopting these regulations as final regulations, and the executor or donor elects under section 7520(a) to use the section 7520 interest rate for a month that is prior to January 1, 2021, then the mortality experience contained in Table 2000CM must be used. If the executor or donor uses the section 7520 interest rate for a month that is on or after January 1, 2021, but before the applicability date of the Treasury decision adopting these regulations as final regulations, then the tables based on either Table 2000CM or Table 2010CM may be used. However, if the valuation date occurs on or after the applicability date of the Treasury decision adopting these regulations as final regulations, the executor or donor must use the new mortality experience contained in Table 2010CM even if the use of a prior month’s interest rate is elected under section 7520(a).

For Transfer Dates in May or June of 2009, you have the choice of using mortality Table 90CM or 2000CM. After June 2009 (and before 1/1/2021), the program will automatically use Table 2000CM.

For Transfer Dates in May or June of 1999, you have the choice of using mortality Table 80CNSMT or Table 90CM. After June 1999 (and before 5/1/2009), the program will automatically use Table 90CM.

For Transfer Dates after April 1989 and before May 1999, there was no transition period and Table 80CNSMT is used.

For dates before May 1989, the program uses Table LN from Treas. Reg. section 20.2031-7A(d)(6).

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