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Dan
Dan, Retired Attorney
Category: Estate Law
Satisfied Customers: 1164
Experience:  Retired from private practice, where trust and estate work was one of my primary areas of work.
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My mother has been granted a life estate (in california) for

Customer Question

My mother has been granted a life estate (in california) for a home of a friend who died. She'd like to sell the house now, and needs to apportion the proceeds between herself and the remaindermen. Everyone agrees to the sale - is there law or convention for the percentages, based on her current age?
Submitted: 5 years ago.
Category: Estate Law
Expert:  Dan replied 5 years ago.
Because the key interested parties are only your mother and the remainderman (no outside parties of interest), they can negotiate a solution between themselves. So the number is XXXXX bit more flexible than it would be for other purposes.

The formal method of valuing a life estate is a series of calculations based on the age of your mother, her life expectancy, and the estimated future value of the property (which requires an estimate of the property's appreciation potential between now and when the remainderman likely would have received the property). If your mom vacates her life estate interest, the remainderman get their future interest at the present time, so the time frame is accelerated.

To illustrate the issues, look at the scenario if the remainderman were to be guaranteed to receive a fixed $100,000 10 years from now, but wanted to take instead the present value of that gift. You would only have to decide on an interest rate to use as the estimated rate of appreciation, and you can back calculate the present value of that future interest. But in your scenario, the future interest does not have a fixed value. Instead, you would have to estimate at what rate the property might appreciate between now and then, so you can estimate the property's future value. Finally, you have to estimate your mother's life expectancy. There are a number of mortality tables that could be consulted, but even then you would have to decide whether to use the table's life expectancies or to vary from them. For instance, is your mother of better health than average for a woman her age, or does she have more health risks than average?

One method to undertake all this is to hire an actuarial firm to do the calculations.

A short cut would be to use one of the tables that have been devised for calculating life estate interests and remainderman interests for purposes such as public benefit calculations. For instance, this link here will take you to a web service that is titled:

DETERMINING THE VALUE OF LIFE ESTATE

This table, published by the Washington State Department of Social and Health Services, only requires the insertion of your mother's age, and it will tell you what percentage of the present value of the property is the portion that they would assign to the life estate. For instance, if mother were age 74, according to the table the life estate represents 53.862% of the property's present value. Whatever value isn't life estate is the present value of the remainderman's interest.

Keep in mind that tables such as this represents a compromise by the Department that is publishing it for the purpose of being able to readily assign a value to something this complex. They know that sometimes the number will be high, sometimes low, but on average things will work out for their purposes. To minimize some of the inaccuracies that might come from using such a table, you could work off or several of them and average the values they give.

Another place that they could fall back to for the purpose of finding estimations of the values of their respective interests would be the life estate calculation formulas presented by many charitable gift entities. These calculations are often needed, for instance, where a party donates something such as their home to the charity but retains a life estate. Their charitable gift dedication is limited to the present value of the remainderman's interest. Because the gift valuation has to pass IRS scrutiny, these calculations use formulas approved by the IRS for this purpose.

One last thing to consider is that the tabulated values might still not be the most equitable way to determine how to divvy up the sales proceeds. For instance, if you mother is giving the remainderman the opportunity to access this asset early because she is voluntarily relinquishing the life estate, might she be in a position to negotiate a larger share of the total in exchange for agreeing to give up the life estate early? To some that might seem mercenary, to others it only looks at this from a capitalistic perspective -- it is a recognition that she is giving up something of value in part in order to allow them to accelerate their interest -- what's it worth to them to get her to do that?

I know that portions of this might have come across as gobbly-gook. I hope that it has been at least somewhat helpful. Let me know if you have any followup questions. If none, please remember to click on the ACCEPT link so that I may receive credit for working on this topic with you. (I'd greatly appreciate it!)


Thank you,

Dan

--------------

The information provided is general in nature only and shall not be construed as legal advice or to create an attorney-client relationship. You should always consult with a lawyer in your state.

PS: If an answer appears to you to have been very helpful, or to have taken above average expertise, and/or research, or if the answer shows an above average amount of time and dedication devoted to your issue, a bonus is nice way to say "Thank you". Thanks!

Customer: replied 5 years ago.
Just a quick follow-up: my mom is 67. If I use the link you pointed me to, it says she should get 65%. If I use the IRS tables and the current applicable interest rate (3.4 says the IRS), it says she gets 39%. This seems so wildly different it seems they're talking about different situations. Any advice on how to resolve this, aside from just picking the higher number and demanding that? I was hoping you could help me boil this down to one number I can tell her, and substantiate it to the 'remaindermen'.

Thanks,
--Jim
Expert:  Dan replied 5 years ago.
Jim - you can see now why I went into the theory behind that calculations! There's a lot that goes into this issue. (For instance, I can also see that you've run across the matter of incorporating the AFR [Applicable Federal Rate]. That's just one of the complexities of doing these calculations if you aren't able to just reference a table.)

The differences in valuations, especially between the IRS calculations and the tables by agencies such as the DHSH and the arises in great part because of the different purposes of those calculations. The DSHS type calculations are looking at determining what the rough value is of what the party gave away (the remainder interest) so that they can figure that into the formulas for determining whether or not the donor has made too much divestment and might then be ineligible for public benefits for nursing home care. The IRS based computations are trying to pin down values to determine the amount that can be deducted for the charitable gift of a remainder interest. The key variables in the IRS tables include the AFR, but also the rate of depreciation that is incorporated into the calculations. The higher the interest rate assumed, the greater the value of the remainder interest; the higher the depreciation presumed, the lower the value of the remainder interest.

I'm concerned about the accuracy of the number you came up with off the IRS tables. I haven't run the calculations myself, but in one sample run I ran across where the life estate holder was age 65 the remainder interest was valued at roughly 47% (using a midterm AFR of 3.4%) using the IRS methodology. See here for that example. That would suggest a valuation of the life estate at closer to 53%.

My concern with using the IRS method for this purpose is that it incorporates depreciation into the value of the property, which basically is a fiction. Most real properties don't actually depreciate. On the other hand, there is an annual cost to maintaining real property, including property taxes, insurance, maintenance, utilities, etc. When giving up the life estate, mom will receive cash, but she will also be relieved of the duty to pay property taxes, property insurance, utilities, maintenance and repairs, at that site. Being relieved of those obligations has a value also, which should be incorporated into the assumptions.

To get an idea of how close to fair or appropriate a 65% valuation would be, I'd like you to estimate the selling value of the property and then figure mom's share of the net proceeds based on 65%. Next, estimate what her cost to live at this property would have been annually (include property taxes, property insurance, utilities, and something for maintenance) at present numbers. Next estimate what her cost to rent a nice apartment would be. The difference in those costs is a fair estimate of what she would bear as an out of pocket cost for not retaining that life estate. Would the money in the bank, paid out annually (I'd use an estimated 3% of it for one year for this calculation), be enough to cover her estimated net excess cost to rent an apartment compared to the estimated cost of living in that house? The concept behind this thought is to say that she was given a gift of housing: how far would that same gift go if it were cashed in and the money was instead was used toward housing in a different venue?

[For example, if the house would sell for a net of $400,000, then 65% would be $260,000. If mom drew 3%, or $7,800, of that $260,000 in the first year, and each year drew an increased amount equal to the rate of return she got on the money, the money would last for approximately 30 years. Would an extra $650 a month cover the approximate difference to her between the cost of renting a nice apartment and the estimated actual cost of living in the house she has the life estate in? If so, then giving up the life estate at that value is reasonable because she is still getting an equivalent gift out of the proceeds: money that could be used to defray her actual living costs somewhere else.]

Unfortunately there are too many variables to be able to give you a valuation from here. But I would be wary about using the IRS valuation method (for determining the applicable charitable deduction of the gift of a remainder interest) because it incorporates a very conservative interest calculation and it incorporates a fictional figure for depreciation. When trying to calculate for a charitable deduction, the party doing the calculations will try to get the highest value possible for the remainder interest to maximize the tax benefit of the gift. That methodology is essentially at odds with the purpose you have here, and doesn't factor in the variables that would be of concern to your parties.

I'm sure that I've thrown more mud into the water, but I am trying to show that the it is not automatically applicable to use the IRS method, which will typically understate the value of the life estate. Also, as mentioned above, I'd like you to do a rough estimate of what your mom's estimated share of the proceeds would do as far as helping to defray her actual housing costs, as a way of estimating what the equivalent value of the life estate when cashed in would be to her: how far would that money go toward her housing costs [since the gift was essentially a gift of housing]?

Finally, I have to come back to the concept that this is a negotiated settlement. While the parties will feel better if they can link the % figures to some authoritative calculations, it still comes down to what it will take to get the job done. The remainderman should keep in mind that if she doesn't give up the life estate, they don't anything until years down the road, and there is no guarantee what the property's value will be then. But at the same time, if they don't agree to let mom sell the property can cash in the life estate, she can't get out from under the obligation to pay taxes, insurance, etc., at this property, and if she is already comfortable living somewhere else then moving to this property may not be something she'd want to do. Negotiations often come down to who is more motivated.

If it were my case, I would present the % figure that is more favorable to mom but still supportable, and let them come back with a counter-offer of a different percent that they think is more applicable. Then you'll know how close the sides are to resolving this informally.

Did I help at all? I hope that it has been at least somewhat useful. Let me know if you have any followup questions. If none, please remember to click on the ACCEPT link so that I may receive credit for working on this topic with you. (I'd greatly appreciate it!)


Thank you,

Dan

--------------

The information provided is general in nature only and shall not be construed as legal advice or to create an attorney-client relationship. You should always consult with a lawyer in your state.

PS: If an answer appears to you to have been very helpful, or to have taken above average expertise, and/or research, or if the answer shows an above average amount of time and dedication devoted to your issue, a bonus is nice way to say "Thank you". Thanks!

Dan, Retired Attorney
Category: Estate Law
Satisfied Customers: 1164
Experience: Retired from private practice, where trust and estate work was one of my primary areas of work.
Dan and 5 other Estate Law Specialists are ready to help you
Customer: replied 5 years ago.
Thanks for all of your time. I didn't get the easy answer I was hoping for (do lawyers EVER do that?!), but you've broadened my understanding significantly, and I'm very grateful for for al of your explanations and the helpful links. I feel confident I can give my mother some advice now that's not just my uneducated guesses. Thanks!

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