A significant part of the net worth of many people is tied up in their homes. Home owners are often caught in a dilemma: they want to remain in their homes but are also aware that the significant appreciation in the value of their home will result in estate tax upon their deaths. As a result, home owners may attempt different methods to avoid estate tax. Unfortunately, as recent cases demonstrate, without proper advice and execution, such attempts can fail miserably, resulting in the home being included in the taxable estate.
In the first case, Mr. Tehan and his children executed an agreement regarding Mr. Tehan’s continued occupancy of his residence. The agreement provided Mr. Tehan could occupy the property as long as he cared to do so, and he was required by the agreement to pay all expenses related to the residence. Thereafter, in 1997, Mr. Tehan executed deeds that conveyed an undivided 4.5% interest to each of his eight children. In 1998 and 1999, he also executed deeds. No consideration was paid to Mr. Tehan by any of his children for the interests they received. In May 1999, Mr. Tehan died. The executor of his estate did not include the value of the residence ($275,000) on his estate tax return, and the IRS contended otherwise. In a Tax Court opinion issued in May 2005, the Tax Court agreed with the IRS, holding that because there was no consideration for the transfers and because the taxpayer retained possession and control of the residence, it should have been included in his taxable estate.
The Tax Court also ruled in favor of the IRS in the Maniglia case in October 2005. In that case, Marie Maniglia transferred her property in Boston to a trust. The deed was recorded, but again no consideration was paid for the transfer. Mrs. Maniglia was the sole beneficiary of the trust during her lifetime. Mrs. Maniglia continued to reside in the property until her death and all other incidents of ownership appeared to indicate the property was owned by the trust, with one exception: Mrs. Maniglia’s son filed a partnership tax return for the property indicating that he and his mother each owned 50% of the partnership. Upon Mrs. Maniglia’s death, her son, as executor, reported on her estate tax return that Mrs. Maniglia owned only 50% of the property. The IRS claimed she owned 100%. Her son, on behalf of the estate, claimed that substance should prevail over form, and the Tax Court seemingly agreed, except that the Tax Court was of the opinion that the ownership by the trust was the true substance rather than ownership by the partnership. The Tax Court held the entire value of the property must be included in Mrs. Maniglia’s taxable estate.
Finally, in the February 2006 Disbrow decision, the Tax Court again agreed with the IRS’s position that the entire value of the decedent’s residence must be included. In 1993, Mrs. Disbrow created a partnership with her children. The sole asset of the partnership was the family residence. She made gifts of interests in the partnership to her children and their spouses. She continued to occupy the residence almost until her death, pursuant a lease that was renewed annually, but she paid rent to the partnership infrequently. Upon her death, the IRS contended the value of the residence must be included on the estate tax return. The Tax Court found the partnership was not organized for the purpose of operating a business, and that Mrs. Disbrow retained a life estate when she transferred the residence to the partnership. Therefore, the Tax Court held the IRS correctly included the value of the property in her taxable estate.
This series of cases demonstrates that the IRS is very aggressive in attacking transfer schemes involving the decedent’s residence that are for less than full consideration and where the decedent continues in possession of the property. These cases also serve as examples of bad planning. There are better strategies to transfer assets and usually with assets other than the personal residence. If you would like to discuss your estate plan, do not hesitate to telephone us.