Photo by Jesse Huisman on Unsplash

Question:

Wife transfers her 50% interest in their house to husband’s revocable trust. Husband dies and 100% of house owned by credit trust in H’s trust of which W is beneficiary. When W dies,  is 50% of the value of the house included in wife’s estate under I.R.C. Sec. 2036 as a retained interest?

Response:

Interesting question. I think the answer is yes.

Typically, any property one spouse leaves another in a credit shelter trust is not included in the surviving spouse’s estate when they die. That’s the purpose of a credit shelter trust, to shelter the trust funds from estate taxes upon the surviving spouse’s death. Most people do not have federally taxable estates with the threshold skirting $13 million (in 2023) and the federal tax system providing for “portability,” which allows a surviving spouse to preserve the estate tax credit of the first spouse to die without doing any estate planning. However, a number of states have estate taxes without portability, which means a credit shelter trust is often used to preserve the first spouse’s estate tax credit, allowing couples to double the amount they can leave tax free.

In most instances, each spouse funds their own credit shelter trust. But you discuss a different situation where, for reasons we don’t know, the couple transferred the entire house to the husband’s credit shelter trust. Perhaps the wife funded her trust with other assets.

As you say, I.R.C. Sec. 2036 is written to include property in a decedent’s taxable estate if they transferred it on paper but, in effect, continued to act as if they owned it by retaining “for his life . . . the possession or enjoyment of, or the right to the income from, the property.” This doesn’t come into play in most estate tax situations because each spouse’s trust would be in their estate in any case. But in the situation you describe, the couple may get their proverbial cake and eat it too. Assuming the wife in your example continued to live in the house, I believe her one-half share would be includible in her estate even though it is in a credit shelter trust that would otherwise not be in her estate. The advantage of this reading is that it would receive a step-up in basis upon her death, presumably reducing taxes on its sale assuming it had appreciated in value since the husband’s death.

Related Articles

Portability Permits Doubling the Estate Tax Exemption for Surviving Spouses Can We Merge QTIP and Credit Shelter Trust Now with the Higher Tax Exclusion? Can Surviving Spouse Protect $2 Million of Deceased Spouse’s Estate from Taxes in Massachusetts?