How Is the Value of a Life Estate Interest in Farmland Determined?

 In Real Estate
Life estate valuation

Life estate valuation

Question:

My stepmother has a life estate for our family farmland. She is 85.6 this month. My three sisters and I are hold the remainder ownership. A company wishes to purchase the land for $5,584,000. We are trying to determine what the value of her life estate would be in order to offer a sale’s agreement.

Response:

The typical method for valuing life estates and remainder interests is to use tables supplied by the Internal Revenue Service here: https://www.irs.gov/retirement-plans/actuarial-tables

They factor in the life estate holder’s age and the section 7520 rate which the IRS publishes each month. Using the Table S (2010CM), your stepmother’s age and the January 2025 Section 7520 rate of 5.2%, your stepmother’s interest in the property is 26.4 percent and you and your sisters should receive 73.6%, or $1,471,904 and $4,112,096 respectively to be exact.

However, you may want to wait to sell the property due to capital gains taxes. Depending on whether your stepmother created the life estate, it may get a step-up in basis upon your stepmother’s death, eliminating any tax on the capital gain. I don’t know what the current tax basis for the property is since it would be affected by many factors including the purchase price, the cost of any improvements made to it over the years, whether you have been taking depreciation deductions on it, and whether it may have received a partial step-up in basis upon your father’s death.

But let’s assume for purposes of an example that the current basis in the property is $1,584,000 so that you would realize capital gains of $4 million on its sale. Depending on your income, this could be taxed at the 15% or 20% rate. There may also be a state tax. Again, for purposes of example, let’s assume your combined federal and state capital gains tax rate is 20%. A sale would result in taxes of $800,000, about a quarter or $200,000 to be paid by your stepmother and the same amount by each of you.

If your stepmother helped create the life estate, rather than your father leaving it to her at her death, then the property would receive a step-up in basis upon her death, bringing it up to its full market value at that time, and eliminating any tax on its sale. An accountant or estate planning attorney can advise you on the current tax basis in the property and whether it would receive a step-up in basis upon your stepmother’s death. (You may need both, an accountant to determine the current basis and an estate planning attorney to advise on the step-up issue.)

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