Case: Rhea Jones, 75, lives in a beautiful coastal town in northern California.
Rhea's home occupies three magnificent acres of bluff property that
overlooks the crashing waves of the Pacific. Since her home sits just
steps away from the dramatic cliffs, Rhea frequently jokes to her friends
about her "living on the edge" lifestyle.
John, Rhea's husband of 50 years, built the custom home ten years
ago. It was truly the realization of a lifelong dream of John and Rhea.
Unfortunately, John passed away unexpectedly five years ago. Now, Rhea
lives alone in the large home. Nevertheless, Rhea is looking forward to
spending her remaining days in this lovely home. Not surprisingly, she
frequently plays host to her children, grandchildren and friends.
Rhea is an active philanthropist. In fact, she spends three days a week
volunteering with local charities. While very wealthy and philanthropic,
Rhea makes only modest yearly gifts. However, she intends to make a substantial
bequest upon her death. Specifically, Rhea plans on distributing her entire
estate to her children and grandchildren, except for her cliff-side home.
Rhea's will provides that the home passes to John and Rhea's favorite
charity upon her death. The home is worth $3 million.
However, at a recent estate planning presentation, Rhea discovered the
benefits of a gift of a remainder interest in a personal residence. In
particular, she liked the potential significant tax savings and the home's
avoidance of the probate process. Also, because the gift is irrevocable,
the local charity would recognize and honor Rhea for her generous gift
at the annual fund raising gala. Of course, Rhea would retain the right
to live in her home for the rest of her life, which is an absolute requirement
to any potential gift arrangement.
Question: Rhea is very excited about this gift arrangement, but she has many questions.
Before she commits to the gift plan, she wants to address several issues.
In order to compute the charitable income tax deduction, Rhea is required
to determine the estimated useful life of her home. How does she do this?
Are there some rules regarding this determination? What are the four basic
options to make this determination?
Solution: In determining the value of a gift of a remainder interest in a personal
residence or farm, depreciation must be taken into account if any part
of the contributed property is subject to exhaustion, wear and tear or
obsolescence. See Sec. 170A-12(b)(1). The tax code requires the straight-line
method of depreciation. In order to compute depreciation, a donor must
determine the estimated useful life and salvage value of the building.
"Estimated useful life" is the estimated period of time that
an individual's property may reasonably be expected to be useful.
In determining this time period, the "expected use" of the property
must be taken into account. See Sec. 170A-12(d). Lastly, the useful life
"clock" starts ticking at the time of a gift and not at the
time the property is built.
Option #3: Individuals may look to the tax regulations for guidance. In particular,
the tax regulations provide two good examples of gifts of a remainder
interest in a personal residence that illustrate the proper application
of the valuation rules. In both examples, the tax regulations use an estimated
useful life of 45 years for a personal residence. See Sec. 170A-12(b)(3)
and Sec. 170A-12(c). These tax regulation examples were also updated,
see T.D. 8886 (9 Jun 2000). While not definitive, the tax regulation examples
are very useful and instructive.
Thus, Rhea could argue that an estimated useful life of 45 years for a
personal residence is a reasonable estimate, since the tax regulations
apply this 45-year figure in both personal residence examples. In addition,
since Treasury did not elect to change the personal residence estimated
useful life examples in its recent update, an individual could assert
that Treasury continues to view 45 years as a reasonable estimate. Of
course, each individual's building and tax situation is unique. Therefore,
individuals should consult qualified counsel before using this option.
Rhea likes the simplicity, time savings and cost efficiency of option
#3. Moreover, she knows that a useful life of 45 years will provide her
with very good tax benefits. Before making her final decision, however,
Rhea wants to understand option #4. The fourth option will appear in Part
6 of this series.
Editor's Note: Crescendo's life estate reserved program uses 45 years as the default
estimated useful life. This default setting is designed to give individuals
a reasonable and safe useful life estimate, since many individuals do
not know the estimated useful life of the building in question. Crescendo
is unaware of any IRS challenge against a legitimate gift of a remainder
interest in a personal residence where the estimated useful life used
was 45 years.
Living on the Edge, Part 4
Living on the Edge, Part 3
Living on the Edge, Part 2
Living on the Edge, Part 1
George's "UT to Green Gift Annuity" Conversion