Question:

I have some questions about a real life example we are facing.

– John and Joan were married in 1999 and entered into a joint Life Estate agreement with regard to a condominium property with the remainder to John’s children.
– John died in 2009. Joan is the sole owner of the property and has granted John’s children a 50% interest in the property
– Joan still lives in the property and is 95 years old.
– Joan now wants to sell the property to help fund her life in a retirement community.

How do we determine how much of the proceeds from the sale of the property is due to and how much to John’s children?

I’ve seen two sets of tables and I’m not sure which one to use:
https://www.irs.gov/retirement-plans/actuarial-tables
https://secure.ssa.gov/poms.nsf/lnx/0501140120

Response:

There are two issues here: First, what’s fair between Joan and John’s children. Second, what will the IRS accept?

With respect to the first question, the parties can do whatever they choose. Either table can serve as guidance.

With respect to the second question, the parties should use the IRS table. Both tables factor in the age of the life estate holder, Joan in your case. Her interest declines as she gets older because her life expectancy also declines. Since she has a right to occupy the premises for the rest of her life, as every year goes by the length of time she will occupy the premises gets shorter. Since her valuation is based in part on the likely length of her tenancy, the value goes down as her likely tenancy decreases.

But length is only one factor in determining valuation. The other is interest rates. A bond you hold for one year will be more valuable at 5% rate of return than at a 2% rate of return. So the IRS table provides different valuation tables based on both age and prevailing interest rates. In addition, every month it issues the AFR or “applicable federal rate” to be used for these valuations (and other purposes). Actually, it issues several AFRs depending on whether a transaction is short-term or long-term and whether payments will be made on an annual, monthly, or quarterly basis.

As I write this, the current mid-term rate for a loan with annual interest payments is 3.57%. Going to the IRS tables, for 3.6%, the interest of a 95-year-old is just 10.3%. On the other table provided by the Social Security Administration it is 22.9%, more than twice as much. This is relevant for tax purposes because Joan can exclude up to $250,000 of any capital gain attributable to her share since she lives in the condominium. John’s children cannot do so since it’s not their home. Following the IRS tables, even if John’s children agree that she receive more than 10% of the proceeds so she has enough to pay for the retirement community, she should only be able to exclude the capital gain attributable to 10% of the proceeds.

However, there’s a counterargument. Even though the tables are clear, there’s also the issue of the bargain. The situation could be that John’s children want to sell and Joan doesn’t. But she might say that she would be willing to sell if she were to receive more than her actuarial share. In that case, here share of the proceeds would be based on a deal, in effect of a sale of her right to stay occupying the condominium, rather than as a gift from John’s children. In that case, I’d argue that she should be able to exclude all of the capital gain attributable to her share of the proceeds, not just the 10% provided by the IRS tables.