Life Estate Sale of Property – Tax Issues

Life Estate Sale of Property – Tax Issues

1967 Bought personal residence 100K

2001 transferred to children estimated FMV 400K but kept a life estate valued @ 175K

2006 children sell property for 475K moved out

Question: Do children have a capital gain of 475-400K

Do parents have a gain on sale of life estate? or is this a sale of their principal residence ?


The transfer to the children was a gift. You should have filed a gift tax return reporting a gift of $400,000 fair value less $175,000 life estate. If you didn't you should call your accountant and address it.

On a gift, the tax basis (what you paid, plus improvements, less costs) carries over to the donee. Thus, if you made no improvements, never depreciated a home office, etc. your children's tax basis is $100,000. Also, since you lived their not the children, the $250,000 ($500,000) home sale exclusion won't be available to them.

It would seem like the sale and the legal documents consummating the sale, should have been two: 1) a sale of a life estate by you to the buyer; 2) a sale of the remainder interest by your children to the buyer. The price should have been allocated to each in the sales contract. Since you still owned the life estate the value of the life estate might be susceptible to actuarial valuation. The difference in the sales price of $475,000 minus the determined value of the life estate, would seem to be the gain allocable to the children.

As for whether your life estate would qualify as a sale of a principal residence is an interesting question.

There are a host of interesting questions that would need to be addressed (yes, I know you asked the question):

  • Does a life estate constitute a sufficient ownership interest under Code Section 121 to qualify?
  • If not how is the gain characterized? If as a capital asset (likely) when does your holding period being? When you first acquired the property (my guess), or when you obtained the life estate.

I don't have all the answers and a quick effort at finding them didn't turn up much. I will be presenting a lecture for the American Institutes of CPAs on tax planning for personal residences in May and will try to post the audio clip of that program in the Seminar Materials section of this website. In the meantime, if you need to have an answer that's right you'll have to hire a CPA or tax attorney to research this. Really interesting questions. Good luck.

  • Do you as parent retain any tax basis or does it all transfer to your children as part of the gift?

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