A legal arrangement involving real property divides ownership into two distinct interests: a life estate and a remainder interest. The life estate grants an individual the right to reside in and utilize the property for the duration of their lifetime. Upon their death, the property automatically transfers to the designated remainderman. An important tax implication arises at the death of the life tenant: the property receives an adjustment to its value. For example, if a parent deeds their home to their child, retaining the right to live there for their lifetime, and the home’s original cost was $100,000 but is worth $500,000 at the parent’s death, the child inherits the property with a value of $500,000.
This valuation adjustment can significantly reduce or eliminate capital gains taxes when the remainderman eventually sells the property. The difference between the original purchase price and the eventual sale price constitutes a capital gain, which is subject to taxation. By adjusting the value to its fair market value at the time of the life tenant’s death, the potential capital gains tax liability for the remainderman is minimized. Historically, this has been a popular estate planning tool, allowing for the transfer of property while mitigating future tax burdens and ensuring continued residency for the life tenant. This mechanism also helps avoid the complexities and costs associated with probate in many jurisdictions.
