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What is the tax on Life Estate Inheritance?

I have inherited farm land...

I have inherited farm land from my mother in a life estate at her passing last year. I have had the land appraised and need to know the taxes I could face when (if) selling. This land has been in the family for 5 generations some homesteaded in the 1870's. It has been cash rented to farmers we know for 20 years. How is the base value establishing for tax purposes when I do not know the purchase price or in some cases homesteaded? The land is located in North Dakota.

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Answered in 3 hours by:
1/25/2011
Brenda Guy
Brenda Guy, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 151
Experience: 20 years of working with income and estate tax issues for families and businesses.
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I would like to clarify your facts first. This is a pretty complex issue.

When you say you inherited a life estate from you Mom what exactly do you mean? Who owned the remainder interest related to the life estate? Was that you?

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Customer reply replied 6 years ago

My mother set up a life estate within her will that basically states that my mother, sister and I own the property jointly. Further that during her life time she will receive all cash from the rental of this property (to pay for her living expenses) and pay the property taxes each year. This will and estate provision was filed in about 1994 (over 15 years ago). She passed away in October so in effect my sister and I are not the sole owners of the land. My sister and I are about to divide the land and put it into our own names and decide at that time if we are going sell or continue renting.

If I wish to sell the land that I will now have in my name, I understand I must pay a state and federal tax on the difference between what I receive in payment and what I paid (nothing) or some arbitrary value. Bottom line, is what will the tax be based on?

Usually a life estate means that title to the property transferred to the heirs with the parent retaining all rights during her lifetime. It sounds like this is what you have. When this type of structure is set up there should be a gift tax return filed. Many years ago the IRS saw this structure as a way to reduce estate tax for the life estate holder and established a rule that says when the life estate is granted to the parent and the children get the retained interest a gift is made of the current fair value of the property. So this should have been what happened in 1994.

As to your question of basis - the basis of a gift is the basis just prior to the gift of the donor. So the basis in the property would be the basis in 1994. As you already understand, this is the original purchase cost plus any improvements made to the property.

You have stated in your question the difficulty of determining purchase cost. This is not unusual. The way I usually approach this is to help the family estimate what the original cost and improvements are. This is not a scientific answer. However, how would the IRS have a better way of figuring out your basis?

I would gather as much information as you can to support what you think the basis is. The worst case is that the IRS would say there is no basis. We all know that cannot be true. Somewhere along the way money was spent by someone to purchase the property. The only records that may be available are property tax records. Most tax collectors have a formula for determining the property tax value basis on the original cost.

I do not know North Dakota property tax law and cannot help with that part of the calculation. The local assessor’s office can probably help you.

This is a long answer and may seem somewhat convoluted. In short I would work to come up with some reasonable cost basis that you can argue if audited on the sale transaction.

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Customer reply replied 6 years ago

I did find a couple of old wills that simply said "all that I own I give to my wife and children for the fee of one dollar and love and affection". Maybe the IRS had a formula for love and affection!

I never thought of a gift tax so will have to see if ND has this requirement.

Thanks for your opinion

Gift tax is federal. Some states may have a gift tax. I don't know about ND. The federal form that would have been filed in 94 is a 709. One of the items requested on the form is the basis of the property gifted. So if this was filed and you can find a copy this might answer your question.
Brenda Guy
Brenda Guy, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 151
Experience: 20 years of working with income and estate tax issues for families and businesses.
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