Does a Life Tenant Have to Pay Inheritance Tax?
Original post by Wilhelm Schnotz of Demand Media
Many times, a landowner wills a piece of property to heirs, with the condition that a current tenant -- often his surviving spouse -- has the right to occupy that property until her death. This lease based upon a tenant's lifespan is known as life tenancy, and doesn't actually transfer ownership of the property to the life tenant, but merely grants her the right to remain on the property. Because of this, life tenants and life tenancies don't affect the methods in which the Internal Revenue Service (IRS) assesses estate taxes.
Life Estate vs. Fee Simple
Long-term land ownership operates in two different methods. In one type, fee simple, owners completely own the land and may do anything they wish with it, and pass it to their descendants upon their death. This is the type of land ownership usually associated with purchasing real estate. In the other form, life tenancy, a tenant receives the right to live on and farm a property, though not to do anything that reduces the property's value, until he dies. The life tenant doesn't own the property for perpetuity, and ownership returns to the original owner at his death in a process known as reversion.
Estate Tax Basics
The IRS levies the estate tax, which is often known as the inheritance tax, when a person dies and her collective possessions, known as her estate, pass into the hands of her heirs. As with the gift tax, the party who receives an inheritance owes no taxes on the items she receives, and taxes are paid by the party that bequeathed the item. In the case of inheritance taxes, the IRS assesses taxes against the estate, which usually pays them out of its holdings before dividing its property among heirs. When an heir, such as a life tenant, receives property, he pays no taxes on it.
Estate Tax Calculations
When a person dies, his executors must value his entire estate, including the property designated to the life tenant. If the aggregate value of this property exceeds the federal estate-tax exemption, which is $5 million as of the time of publication the amount that exceeds the exemption is subject to taxation. A taxpayer may also apply any remaining amount of a unified credit, a one-time amount that may be used in lieu of paying gift or estate taxes for a taxpayer, to lessen the amount of tax due. As of the time of publication, the maximum unified credit amount is $345,000.
Before a husband dies, he grants a life tenancy to his wife for the property upon which their home sits, which is worth $800,000. The property will revert to his eldest son upon her death. When he dies, his heirs take account of his estate, totalling assets' value and deducting debts, and determine the net value of the estate is $6.1 million. As the deceased previously used his entire unified credit to avoid paying gift taxes, a representative files a form 706 with the IRS declaring the estate's value, which is then examined by the IRS, and the taxable amount is determined. The estate's value is above $5 million, leaving it with a $1.1 million tax base. This amount is taxed at a flat 35 percent, leaving the estate with a $385,000 tax liability. The estate's executor settles this, either by liquidating other assets or tapping into investments, then distributes the remaining estate, with a post-tax value of $5,715,000 to be divided among his heirs. Neither the wife nor any other heir pays inheritance taxes, nor does the son owe additional taxes when his mother dies and the property reverts to his ownership.
- IRS.gov: Publication 950 - Introduction to the Estate and Gift Tax
- IRS.gov: Frequently Asked Questions on Estate Taxes
- Bankrate.com; Estate and Gift Tax Amounts; Kay Bell; January 2011
- Social Security Administration: Life Estates
About the Author
Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.