Life Estates don’t work. Life estates are bad for tax. Right to resides are 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: Butterworths
Australian Legal Dictionary, p 692.
Life estates are created during your lifetime. However, most are created in a Will.
Life estates 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 will 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, and that is a dangerous practice.
STAY AT HOME CHILD
Young Jonny has looked after his ageing mum. His siblings selfishly got married, had children and lived a life. So Jonny gets a special reward. After her death, mum allows Jonny to live in the family home until he leaves or 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 toy boy 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.
If you are not convinced then here are the clauses to use in the Specific Gift.
RIGHT TO RESIDE
[Toy Boy Full Name] exclusive right to live in [10 Current Street, Suburb] or any home that I own at the date of my death for life or until [Toy Boy Full Name] stops living in the property for more than 6 months, whichever is the earlier. All rates, taxes, insurances and other expenses to be paid by [Toy Boy Full Name]. The property to be maintained in a clean and tidy state by [Toy Boy Full Name].
[Toy Boy Full Name] a life estate in [10 Current Street, Suburb] or any home that I own at the date of my death for life. All rates, taxes, insurances and other expenses to be paid by [Toy Boy Full Name].
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 loses 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.
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 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.
For more legal advice telephone us.
Adjunct Professor, Dr Brett Davies, CTA, AIAMA, BJuris, LLB, Dip Ed, BArts(Hons), LLM, MBA, SJD
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