## How Do We Calculate the Value of Our Life Estate?

Photo by Denys Kostyuchenko on Unsplash

### Question:

My husband and I have a home in Florida and the deed is registered so that we have a life interest and our two daughters have a remainder interest. I thought we could just use the “remainder interest table factor” to determine the remainder interest for our daughters when we are a certain age. But do U.S. interest rates come into play I don’t understand why I can’t just use the remainder interest tables. We bought the home in 2001 when I was 50 years old (born in 1951) and my husband was 51 years old (born in 1950). What would there remainder interest be in 2023 if the value of the house was \$1.2 million at that time?

### Response:

There are a number of remainder interest tables around which may be used for various purposes, for instance if you and your daughters simply wanted to determine how to divide the proceeds of the sale of the property or how to allocate the cost of an improvement. However, for tax purposes the IRS has its own tables that reflect current interest rates. Interest rates matter because the value of the right to use the property for a period of time is higher if interest rates are higher.

To explain how this works, less assume that instead of a house you and your husband had a bond worth \$1 million. Let’s also assume that you knew how long you would live and for our example that’s 10 years so you have the right to receive interest on the bond for that amount of time. If the bond were paying interest of 1% per year, which was the prevailing rate just a few years ago, you would receive \$100,000 over 10 years (\$10,000 x 10 = \$100,000). But at today’s rates you could receive much more. If the bond were paying 5% annually, you would receive \$500,000 over the next decade (\$50,000 x 10 = \$500,000). In the same way, the value of your life estate increases along with the interest rate. (This relationship also explains why the value of bonds dropped dramatically when the Federal Reserve quickly raised interest rates to bring down inflation. A bond paying interest of 1% is not desirable when it’s possible to buy new bonds or treasuries paying 5%.)

As the value of life estates fluctuates along with prevailing interest rates, it also decreases over time as the life tenants get older and their life expectancy gets shorter. The IRS provides life estate tables that can be downloaded here https://www.irs.gov/retirement-plans/actuarial-tables. It also provides new interest rates for this purpose, known as the “Applicable Federal Rate,” every month. In fact, for life estates you are supposed to use its “section 7520 rate,” which is 120 percent of the applicable federal mid-term rate in effect for the month. In addition, since both you and your husband are life tenants of the property, so you should use the IRS’s two-life table.

Using the two-life table in December 2023 you and your husband were 72 and 73 years old, respectively, and the section 7520 rate was 5.8%. The result is that your interest was 62% and your daughters’ interest 38%, or \$744,000 and \$456,000.

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