Dear Harry,
My mother just passed away at the age of 102. She had retained a life estate in her residence. The lawyer handling the estate is saying that the entire value of the property is counted in her estate for Massachusetts estate tax purposes. I had read somewhere that the life tenant owns a portion and the remaindermen own a portion. I am one of seven children. This is especially problematic if true since it would bring Mom’s estate in Massachusetts just over $1 million, so the tax would be on the entire amount. (I’m estimating the value of the house could be as high as $1.25 million depending upon the appraisal.)
Dear Reader,
Your lawyer is right. The entire value of the property is in your mother’s taxable estate and it will be subject to a Massachusetts estate tax of about $50,000 (assuming her estate holds no other assets), relatively modest in terms of the total value of the estate. For better or worse, this is the result of the fact that your mother lived in Massachusetts. It, along with Oregon, has the lowest state estate tax threshold in the United States at $1 million. The federal estate tax threshold is currently just over $12 million, so very few estates are subject to the federal estate tax.
The property will not be in your mother’s probate estate, which can be a bit confusing. It passed automatically to you and your siblings upon your mother’s death without having to go through the probate process.
The split you describe would have happened if the house had been sold during your mother’s life. Under a life estate you all, your mother and her seven children, were co-owners of the house. Your mother’s form of ownership gave her the full right to possess and occupy the house during life, or to receive any rents had it been rented out. If it had been sold, the proceeds would have been split between your mother and her children according to tables provided by the IRS. Under those tables, your mother’s interest declined with every year along with her life expectancy. The IRS also factors in prevalent interest rates with the value of the life interest being larger the higher the interest rate. At age 102 and at recent low interest rates, had the property been sold during your mother’s life, she would have received only about 5% of the proceeds.
However, that may not have been a good result in terms of taxes. While it would have removed 95% of the proceeds from her taxable estate, you and your siblings would have had to pay tax on the capital gain on your 95% of the proceeds. Your mother could have only applied her $250,000 exclusion of capital gains only to the small portion of the proceeds coming to her. Instead, inclusion of the house in your mother’s taxable estate eliminates the capital gain. This is because the property received a “step-up” in basis. As a result, upon the property’s sale the capital gains will be calculated as the difference between the sale proceeds and the value of the property upon your mother’s death, rather than the value when your mother (or your parents) purchased the property. This will likely result in far greater tax savings than the relatively small Massachusetts estate tax.
By way of example, if your parents purchased the property for $250,000 and you had sold it for $1.25 million during your mother’s life, the capital gains taxes could have been as much as $250,000 depending on your and your siblings’ tax brackets. Now you won’t be paying this tax. Though I’ve made up these numbers, the principle is the same — the capital gains taxes are likely to be much higher than the estate tax.
Harry S. Margolis practices elder law, estate and special needs planning in Boston and Wellesley, Massachusetts, and is the majority owner of ElderLawAnswers.com.. He is author of The Baby Boomers Guide to Trusts: Your All-Purpose Estate Planning Tool and answers consumer questions about estate planning issues at www.AskHarry.info.