Question:

April who is 93 years old owns property worth $1 million which she bought for $50,000. It’s subject to a $700,000 reverse mortgage. To further complicate the picture, April transferred a remainder interest to her son in 2014 (retaining life estate interest) but he passed in 2017, and April, as intestacy heir, inherited the remainder interest back from his estate.

She wants to stay in home but needs more cash to do so. Lots of investors are interested in the property and are willing to let her continue living there. I suggested April could sell the remainder interest to a third party (which would pay off reverse mortgage) and retain a life estate interest.

So if April sells remainder interest now (in 2025), is the remainder interest basis the value as of 2017 when here son died and she inherited back his interest? This feels like  a law school exam question.

Response:

Yes, it does feel like a law school question, especially the calculations. April’s $50,000 basis in the property did get adjusted, or “stepped up,” when her son died since she inherited the remainder interest from him.

The amount of the adjustment would be based on the value of the son’s interest in property in 2017. The IRS provides tables here for determining the respective values of life estate and remainder interest holders based on the age of the so-called life tenant and current interest rates.

We know that April was 85 in 2017 and the Section 7520 interest rate at the time was around 2.4% (though it fluctuated from month to month). Using those figures and the IRS table, April’s interest in the property at the time was 14% and her son’s 86%. (The older the life tenant, the lower her ownership interest since she presumably has fewer years to possess the property.)

If, by way of example, the fair market value of the property was $700,000 in 2017, then the property’s basis would have been stepped up by $602,000 ($700,000 x .86 = $602,000). The 14% share that April already owned would keep its $50,000 basis, so $7,000 ($50,000 x .14 = $7,000) would be added to bring the new basis to $609,000.

This would significantly reduce the capital gains April would have to pay if she were to sell the remainder interest in the property to investors. If she did so for $800,000 so she would have $100,000 of cash after paying off the reverse mortgage, she would realize capital gain of approximately $279,000 (based on our $700,000 2017 valuation).

To arrive at this figure we have to look back at the IRS life estate tables using April’s current age and the current Section 7520 rate of 4.65% (in October 2025). Interestingly, they don’t change things much. Even though April is eight years older and as a result has a shorter actuarial life expectancy, the higher interest rates increase the value of her life estate interest. So if she sold a remainder interest it would still be considered selling about 86% of the property value. Applying this percentage, the basis of the remainder interest would be $521,000 ($606,000 x .86 = $521,160). The capital gain would then be $279,000 ($800,000 – $521,000 = $279,000).

The final question is whether April can use her $250,000 capital gains tax exclusion for the sale of her personal residence even though she’s retaining a life estate. I think the answer is yes, but I’d consult with an accountant to be certain.