Tax Effective 3-Generation Testamentary Trust
Tax Effective 3-Generation Testamentary Trust
Mutual Will - Non Tax Effective
Single Will - Non Tax Effective
‘Life Estates’ don’t work. Life estates are bad for tax. ‘Right to reside’ is not better.
You own the land. You can give a person (life tenant) a right to live in or rent out the property until the life tenant dies. When the life tenant dies the ‘remainderperson’ get the property.
Life estates are created during your lifetime. However, most are created in a Will.
Life estates in a Will
Life estates in a Will are silly and old-fashioned. You should instead leave everything as a percentage. If you want to benefit one particular person then increase their percentage. Therefore, your Residuary Beneficiaries work out what they want to do with your estate. Life estates are just a prison sentence. Life estates are commonly put in place by people that want to rule from the grave. That is a dangerous practice.
STAY AT HOME CHILD
Young Jonny looked after his ageing mum. His siblings selfishly got married, had children and lived a life. So Jonny gets a special reward. After Mum’s death, she allows Jonny to live in the family home until he dies.
Sweet as that all sounds, that is a mess and a recipe for disaster.
1. Before death, mum suffers a stroke. She is moved into a nursing home. Mum is of unsound mind and the government/children sell the family home. It now attracts Capital Gains Tax and Land Tax. Poor Jonny misses out.
2. Or, at mum’s death, Jonny is now stuck in the house. Jonny wants to see the world and get a life – but he has no money. He just has an old house to wander around in. Perhaps, Jonny wants to get a smaller newer apartment. He can’t. He is trapped in a big ageing house that no one has any interest in looking after.
Instead, Mum should increase the percentage that Jonny gets from her estate. For example, Jonny gets 50% of the estate and his brother and sister get 25% each. Jonny is free to use his 50% of mum’s estate as he sees fit. He is not tied down.
HOT SECOND HUSBAND
82-year-old Mavis finds a 48-year-old toyboy at her Bridge Club. He is not bright. He is not wealthy. But he is a lot of fun and as handsome as sin. Mavis, in her Will, gives a life estate to this young fellow. Maybe they got married, maybe they just lived together. It makes no difference.
Mavis dies. The toy boy is now stuck in a big house. He can’t sell it. He can’t maintain it. And then he suffers a stroke and moves into a cheap retirement home because he has no money. The house is left derelict.
Instead, Mavis should have left a percentage of her estate to the toy boy. He is then free to use the money to enjoy his life.
Not convinced? Start building a 3-Generation Testamentary Trust Will on our website. For free see the wording to put in your Will for:
- RIGHT TO RESIDE
- LIFE ESTATE
Right to Reside v Life Estate
The Right to Reside can’t be sold. The:
- toy boy
- stay at home child
- hot new 2nd wife
- other unlikely people
all lose the right of possession when they stop living in the home. In contrast, the owner of the life estate can rent out the property. The owner of the life estate can even sell the life estate.
Adverse taxation of life estates
Life estates are riddled with tax uncertainty. Two conflicting views were taken as to what occurs when a life interest is granted. Did the grant create a new asset? Or is the grant of such an estate a part disposal of an existing asset. See S Barkoczy and P Cussen, Capital Gains Tax and the Grant of Life and Remainder Interests under Wills: the Debate
Between the Creation and Part Disposal Views (1993) 22 AT Rev 209.
PS LA 2003/12
PS LA 2003/12 is relevant to the ending of a life tenancy. This is if the trustee has the power to distribute assets in a testamentary trust to end the life tenant’s interest. What happens when the life tenant dies and the asset goes to the remainderperson? PS LA 2003/12 states that the remainderperson gets the CGT section 128-15(3) exemption.
In contrast, what happens if the life tenant gives up the life tenancy while still alive? What are the tax consequences of terminating prematurely a life interest? TR 2006/14?
The trustee is treated as the relevant asset ‘owner’. The trustee’s cost base is the cost base of the asset in the deceased’s hands. Or, if it was a pre-CGT asset, its market value at the date of death (see paragraph 18).
What about the beneficiaries? They also each have separate CGT assets. These are their ‘trust interests – the equitable life and remainder interests’ (see paragraphs 24 and 188). The beneficiaries’ interests in the testamentary trust have a cost base equal to their market value (see paragraphs 26 and 144).
Get a valuation of the life estate and remainderperson’s interests to find the cost bases.
Are the assets that originally formed part of the deceased’s estate exempt from CGT? Yes, but only if they pass from the executor to the remainderperson under the terms of the Will (paragraph 45). This is just repeating PS LA 2003/12.
Thankfully, the ruling states that the life tenant does not make a capital gain when they die (paragraph 43 and 44). I would have thought this obvious.
But if the life tenant surrenders their interest, CGT event A1 happens. This is to the life tenant (see paragraph 66). But if no money changes hands or the surrender is not at arm’s length, section 116-30
ITAA97 treats the person surrendering the interest as receiving the market value of the interest they surrender (see paragraph 68).
But the distribution to the remainderperson involves assets that originally belonged to the deceased. And the remainderperson getting the asset is under the terms of the Will. Therefore, it should be free from CGT under s 128-15(3). But the ATO does not say that the ‘early’ inheritance is in accordance with the Will. We are in doubt.
Remainderpersons don’t get the ‘principal place of residence exemption’
What if the ATO successfully argued that an early release by the life tenant was not in the terms of the Will? Then the executor realises a capital gain under CGT event E5 or E7. Both the ATO and I agree that this approach applies in dealings between the life tenant and remainderperson. This is where the life tenant gets payment for relinquishing the share or part of the proceeds of the sale. But I would think the ATO is wrong to invoke CGT if there was merely an early surrender by the life tenant.
Other issues are calculating the cost base and the loss of the principal place of residence exemption.
For example, your mum and dad die. Your alcoholic brother gets a life estate. You get the remainderperson interest. Your brother is young. The property is worth $1m. The actuary gives your alcoholic brother a cost base of $700k. Your cost base is $300k. A year later your brother dies of alcoholic poisoning. You are deemed to have acquired the $1m property for $300k. There is no principal place of residence. You sell the property for $1m. You have made a $700k capital gain to put into your tax return.
Life estates are bad because they don’t work and suffer harsh tax treatment. Life estates are best avoided in your Will.
But you may be able to overcome this under section 118-195 Income Tax
Assessment Act 1997 (Cth) .
Life Estates and Right to reside – 4 additional problems
When drafting and administering life interest trusts consider:
- who pays the expenses and outgoings?
- the risk of family provision claims – a life tenant may still challenge your Will to seek the removal of the life estate
- providing for substitute accommodation – this is just a ghastly mess. Your children want their step-parent to live in a tent on a big block of land (to maximise capital gain). And the stepparent wants to live in a snazzy apartment – with little capital appreciation
- the choice of trustee of a life interest trust – who are the executors?
Life Tenant challenging your Will
A family provision claim is where your surviving spouse feels that they have not been adequately provided for in your Will. An order from the court for provision to be made by way of a portable life interest is called a “Crisp order”.
A Crisp order gets its name from the decision of Holland J in Crisp v Burns Philp Trustee Co Ltd.
It is often made by judges in circumstances whereby your surviving spouse wishes to ensure that they are given sufficient provision without unfairly prejudicing other beneficiaries who may have competing claims (such as the children of your first marriage).
Ipp JA in Milillo v Konnecke  NSWCA stated:
“… a Crisp order may entitle a plaintiff, from time to time, to require the executor of a will to sell a home devised by the will, or otherwise owned by the estate, and to use the proceeds for purposes that may include purchasing another home for the plaintiff’s use and occupation, or providing accommodation for the plaintiff in a retirement village or similar institution, or in like accommodation providing hospitalisation and nursing care. The flexibility provided by such an order underlies the notion that a Crisp order confers a ‘portable life interest’.”
For more legal advice telephone us.
Adj Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, LLM, MBA, SJD
Legal Consolidated Barristers and Solicitors
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