A retained life estate is a gift plan defined by federal tax law allowing the donation of a personal residence (to include a vacation home) or farm with the donor retaining the right to live on and use the property. A life estate may be retained for one or more lives or it may be retained for a term of years. All routine expenses—maintenance fees, property taxes, repairs, etc.—are generally the responsibility of the donor. The donor receives income tax benefits in the year of the gift (the property is irrevocably deeded to the charity) and estate tax benefits can be realized.
For the purposes of taxes, the property within a retained life estate is divided into two parts:
- The "life estate value" of the donor's retained right to live on (occupy) the property for both the donor's or the donor's and his or her designee's (usually the spouse) actuarial life expectancy. This is a calculation for tax purposes and not a limitation of the time the donor and/or spouse can occupy the property.
- The "gift value" is the difference between the market value of the property and the calculated life estate value. This determines the amount of the charitable income tax deduction that would apply in the year of the gift (this is subject to appropriate carry-forward rules if necessary).
At the time of death of the final owner of the life estate, the property passes into the possession of the charity.
A sale of the property that is subject to a life estate can often be accomplished in partnership with the charity. At the time of the sale, the remaining value of the life estate is calculated and the proceeds from the sale are divided proportionately between the charity and the donor. The donor may also decide to gift the remaining value of the life estate to the charity and, in so doing, would receive a charitable tax deduction for the value of the life estate at the time of the gift.
A retained life estate allows the donor to maintain his and/or her lifestyle and, at the same time, make a significant gift to a charity.
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