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E-Alert - 2036 Is Not Just for Family Limited Partnerships
In past FaxAlerts we have informed you how the IRS has had successes in using IRC § 2036 to pull back transferred partnership assets into the estate of a decedent, thwarting the taxpayer’s plans to obtain a discount. These victories have emboldened the IRS to apply the requirements of IRC § 2036 against other types of intra-family transfers.
IRC § 2036(a) provides:
The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death ―
(1) the possession or enjoyment of, or the right to the income from, the property, or
(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.
The decedent in Estate of Tehan v. Comm’r., T.C. Memo 2005-128, purchased a condo in Chevy Chase, Maryland in 1990 for $240,000. In 1997, he transferred full ownership of the condo to his eight children via a series of conveyances. In connection with the transfers, he entered into an agreement with his children, an essential part of which stated:
Timothy J. Tehan shall have the sole and exclusive right to the use and occupancy of the Property for such period of time as he desires. While he is occupying the Property, Timothy J. Tehan shall not pay any rent, but shall be solely responsible for the payment of any mortgage secured against the Property, the monthly condominium assessment, the annual real estate taxes and insurance premiums on the Property, and all costs or expenses in connection with the maintenance and repair of the property.
. . . no owner shall sell, hypothecate, pledge, assign or otherwise, transfer with or without consideration any part of his / her interest in the Property to any other person without first offering his / her interest first to Timothy J. Tehan.
The IRS argued the following factors caused inclusion under IRC § 2036, even though it conceded that title was transferred to the children via the series of deeds:
1. No consideration was paid by the children:
2. The decedent paid all the expenses for the condo before, during, and after the transfer of title to the children;
3. The decedent did not pay any rent for the occupancy of the condo before, during, or after the transfer of title to the children;
4. The decedent’s “possession or enjoyment” of the condo was undisturbed during and after the transfer of title to the children;
5. The decedent did not need to seek approval from the children to have guests stay at the condo or to redecorate it;
6. Even if the decedent had not paid expenses to maintain the condo during and after the transfer of title to the children, the children would not have sought to evict him; and
7. Legal title shifted progressively from the decedent to the decedent’s eight children – 36%, then 72%, and finally to complete ownership. However, the decedent still paid the expenses to maintain the condo.
The children argued that the first two series of transfers left the decedent as a tenant-in-common with the non-exclusive right to use and enjoy the property. They claimed the third conveyance gave them exclusive ownership of the condo with no retained life interest by the decedent. They claimed the occupancy of the property by the decedent was in exchange for payment of all the expenses associated with the condominium. The children took the position that they bargained away their right to use and occupy the property in exchange for the decedent’s agreement to pay all the expenses associated with the condo.
The Court held that the IRC § 2036 applied to bring the full value of the condo back into the decedent’s estate because he had an express agreement to use and occupy the condo; pay all the expenses associated with the condo; and otherwise treat the condominium as his own. The court distinguished this case from Estate of Barlow v. Comm’r., 55 T.C. 666 (1971), because that case involved the decedent paying fair market rental for use of the property where in this case the decedent merely paid the expenses associated with the property.
Given the increased scrutiny the IRS is giving to various estate planning strategies involving lifetime transfers at a discount, it has become more important than ever to refer your clients to a knowledgeable Estate Planning attorney that is familiar with recent developments. Because of its affiliation with the American Academy of Estate Planning Attorneys, the attorneys at the Law Firm of Morris, Hall & Kinghorn are acutely aware of developing trends in the law as they happen.
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