gift, inheritance or sale?

[ljwalters]

Clients aging parents gave there 3 grown children thier working farm 5 years ago in the form of an LLC. There has been a K-1 ever since.

Here is the kicker.

First the lawyer had each childs basis as $90,000.

parents die, now the accountant says "well actually the tital change document stat that there was a $1 exchange for the ranch.

The parents did live at the ranch until they died (last year).

NOW the K-1 for the sale of the farm showes a capital gain of $95000. This was basicaly inheritance.

If nothing else ther would have been $40,000 in gifts to each child and spouse at the time of transfer.

What are your opinions are these taxpayers just as they say SOL.

Linda and buddy

[Terry D EA]

My take on this is it is a taxable sale. When they were given the property before the parents died, their cost basis was their parents cost basis divided by the number of children. If the farm was indeed sold to them for $1.00 then that is their basis and by your post there is taxable gains. What would be helpful is if you could obtain the documents from the time the parents gave or sold the children the property.

Did the LLC own the property or the parents?

>>>>NOW the K-1 for the sale of the farm showes a capital gain of $95000. This was basicaly inheritance.<<<<< This is not an inheritance and is a sale of business property

Provide some more information if you can.

Terry D.

[RoyDaleOne]

The $1.00 on the deed is irrelevant.

There is some hope, but it is to complex to discuss in this forum, and I am not sure that anything can be change.

However, from the facts, if correct, as posted I am sure someone did not know what should have been done when the parents were alive. There maybe more to the story.

[RoyDaleOne]

The main concept is that full and adequate consideration was not paid for the transfer of the farm to the partnership(llc) and therefore the value of the farm is included the descendent's estate. This results in a stepped up basis for the farm and the possibility of estate tax being due.

[OldJack]

The main concept is that full and adequate consideration was not paid for the transfer of the farm to the partnership(llc) and therefore the value of the farm is included the descendent's estate. This results in a stepped up basis for the farm and the possibility of estate tax being due.

I agree partially with RoyDaleOne that $1 was not adequate for a sale and I doubt that amount was ever tendered. Further, I believe there was a gift of the parents tax basis when the title to the farm was placed in the LLC. As the parents did not own the farm at death, there is no step-up in basis to FMV regardless if they retained an interest by living there. Although, I could see an argument for that position I would think placing the title in an LLC hurts that position due to the concept that federal tax recognizes property by state law. I would challenge the 1065 tax preparer to amend LLC tax return to show taxable gain based upon parents gift basis.

[RoyDaleOne]

As, I tried to state, the need is for someone that is competent in this situation.

[ljwalters]

I was wrong on one point.

The deed states that the parents gave title to the children (3) for the one dollar. Then the children formed the LLC to handel the income.

Later the mother gifted an additional 42000 into the llc. The parent were intitled to stay in the farm house until they died. The land was leased to a farmer which is where the income came from. The lease was in existance when the original title was changed. The income in 2007 was 12000 from the lease. The children paid the tax on the income thru the llc k-1's. Mother died in the home, father died 2 days later in the hospital. My client doesn't remember if the title actually states that parents had right to stay in family home. He is bringing me the deed to read.

I feel that it is gift, with stipulation and hence inherited, and steped up basis. Sence I did not to the llc return I wanted more imput in the form of oppinions. Then I have permission to call the preparer (not cpa or even EA as far as I can tell) and discuss the options.

Linda and buddy

[OldJack]

I feel that it is gift, with stipulation and hence inherited, and steped up basis.

Well.. those facts certainly make a difference. I would argue that when the members of the LLC received the property and income from the LLC they had accepted a gift of the property and the parent had relinquished ownership even though parent was allowed to remain on the property. Any such parent minor "remainder interest" would have been irrelevant. You can't get to inheritance (with a stepped-up basis) from what is truly given and accepted. In my opinion it is clearly a gift with the LLC's basis that of the parents. Its too bad these folks followed some "tax expert's" advice.

BTY, when you look at the transfer document you will likely see the $1 "plus other valuable consideration" type terminology. The $1 dollar is meaningless with regards to income taxes.

[mgmea]

>>"Any such parent minor "remainder interest" would have been irrelevant. You can't get to inheritance (with a stepped-up basis) from what is truly given and accepted." <<

Where's Bob Kamman when you need him? That the parents continued to live in the farmhouse is not irrelevant. It's the $64,000 question that gets you the stepped us basis. The applicable code section here is:

SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.

2036(a) GENERAL RULE. --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 an 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 --

2036(a)(1) the possession or enjoyment of, or the right to the income from, the property, or

The question now becomes "what did the parents retain the possession or enjoyment of"? The farmhouse for sure, so we step that basis up. The rest of the farm might be a good question for the tax court. Maybe they've already decided that one. I can't recall all of the court cases that were brought up the last time this was discussed on the old ATX board, I'm sure Bob could though.

[OldJack]

The question now becomes "what did the parents retain the possession or enjoyment of"

Had the life estate not been with a related party I might agree, but that is not the facts in this case. It is questionable, in my view, that this was a life estate, rather an obligation or understanding of trust accepted by the children to care for their parents. There appears to have been clear actions by parents and children to transfer the property as a gift (probably to qualify for Medicaid if needed). You can't now just ignore those transactions because it would save taxes. Do you think if your parents live in your house they would have a life estate?

[ljwalters]

This property is in Nebraska. Nebraska has the same laws for determining state medical benifits as CA which is a 5 year look back and a $1 sale of assets would disqualify them from said benifits.

The parents were unable to continue to take care of the farm, overseeing the lease and maintaing the rest of the farm and the children took it over.

I still have problems finding the letter rullings and court cases that pertain to specific cases. If the fact that the hiers put the farm in an LLC cause a problem with inherits, I can accept that.

It just seem crimminal that BAD tax and or leagle advice can cause such a hardship on the taxpayers.

Linda and buddy

Thanks for all your input

[mgmea]

Had the life estate not been with a related party I might agree, but that is not the facts in this case. It is questionable, in my view, that this was a life estate, rather an obligation or understanding of trust accepted by the children to care for their parents. There appears to have been clear actions by parents and children to transfer the property as a gift (probably to qualify for Medicaid if needed). You can't now just ignore those transactions because it would save taxes. Do you think if your parents live in your house they would have a life estate?

A formal life estate is not required for Sec. 2036 to be applicable. All that is required is a transfer of property for less than FMV and a retaining of an interest in that property. The courts have ruled dozens of times that a formal life estate is not necessary to retain an interest in the transferred property. Here is an excerpt from Peck v. United States 65-2 USTC:

"[implied Agreement].

From these facts the Commissioner determined that an implied agreement or understanding existed between the decedent and the son that she would continue to live on the property and consider it her home for the rest of her life. The plaintiff contends that there was no such agreement, either express or implied, or silent, or tacit, or of any other type.

The determination that an implied agreement or understanding existed is presumed to be correct and the burden is on the plaintiff to show by the greater weight or preponderance of the evidence that no such implied agreement or understanding existed.

The Government here does not dispute the fact that the deed to the property showed the full legal title in the name of the plaintiff, Col. Peck. Nor does it contend that there was any written agreement between the decedent and Col. Peck stating that she would live on the property. Of course, no such written agreement is necessary in order for the Government to prevail on this question, but an implied or tacit or silent understanding to that effect is necessary for the Government to prevail."

The goverment prevailed in this case and the house was included in the gross estate. The court case results that a formal life estate is not required for a retained interest to exist is so widespread that it is even reflected in the instructions to Form 706.

In the case at hand, the parents transferred the farm for $1 with the implied agreement that they could live in the house until they died. How is this not a transfer for less than FMV with a retained interest?

[Lion EA]

But, the parents didn't give the farm to an LLC; they gave it to their children. The parents didn't retain much of a life estate if the children were free to (and FELT free to) transfer the house to an LLC. That's the part that concerns me.

[Gail in Virginia]

But, the parents didn't give the farm to an LLC; they gave it to their children. The parents didn't retain much of a life estate if the children were free to (and FELT free to) transfer the house to an LLC. That's the part that concerns me.

But isn't an LLC a disregarded entity? They did not transfer the property to a corporation or sell it to another party, they merely restructured their own ownership of the property. If the parents gave the property to more than one child, the parents created a de facto partnership. The children merely formalized this into an LLC. I don't know enough law to really be sure, but this is how it seems to me.

[Lion EA]

Only a single member LLC is a disregarded entity, unless it elects to be taxed otherwise. The multiple member LLC that these children actively formed defaults to a partnership unless they elect to be taxed as a corporation. Can you still have an implied life estate when an entity separate from your children or family own the house? I can see where you could ask the children what they implied by letting parents live there. But, how do you ask a partnership and how does it show you what it implied? Probably by the partnership agreement saying it won't sell the house until the original owners leave or pass away. Now, it's written and not at all implied. Have you read the partnership agreement? The transfer deed?

[lbbwest]

Clients aging parents gave there 3 grown children thier working farm 5 years;

Were gift tax returns filed?

ago in the form of an LLC.

IF they gifted "in the form of an LLC" that would be the parents partnership shares. Later posting states LLC CREATED.

There has been a K-1 ever since.

Here is the kicker.

First the lawyer had each childs basis as $90,000.

parents die, now the accountant says "well actually the tital change document stat that there was a $1 exchange for the ranch.

The parents did live at the ranch until they died (last year).

NOW the K-1 for the sale of the farm showes a capital gain of $95000.

(Who calculated Gain and HOW?)

This was basicaly inheritance.

HOW can you say that this was basically (sic) an inheritance when your first sentance says that it's a gift?

If nothing else ther would have been $40,000 in gifts to each child and spouse at the time of transfer.

Again WHERE is this coming from?

WHERE did basis come from? This convoluted Hillbilly Estate Planning offers various options. True gift BASIS is donor's BASIS, but gift tax is based upon FMV date of gift. LLC adhere to partnership accounting which requires Inside LLC and outside (partner) basis.

What are your opinions are these taxpayers just as they say SOL.

Linda and buddy

[OldJack]

The goverment prevailed in this case and the house was included in the gross estate.

This case appears to have been only arguing about including the property in the gross estate.

We should not forget an important factor.. that the children received the income from the farm. Parent cannot assign farm income to others if the parent owns the property. It was a completed gift.

I fully agree that had the children not received such benefits of ownership there would be a life estate that could be stepped-up on death of the parents.

[ljwalters]

Ibbwest

No gift tax return was done.

I don't know where the lawyer got his figures unless it was the value of the farm divided by 3.

The llc preparer calculated the gain.

There was no wording of gift in the deed or the llc papers. Simple fact, giving the farm to kids for $1 suggests it was a gift.

the 40,000 comes from the fact that the parents can without filing gift tax each give the kids 10,000 and the spouses 10,000 which adds up to 40,000. I was just brainstorming for the purpose of finding the proper way to approach this situation. I do agree that if gifted the original basis of the farm would carry over the kids.

We all know if the value of the farm was enough to cause a tax due from inheritance the gov would null the sale. Its not can the kids do anything to save themselves.

I am to receive a copy of the llc papers some time today and I will look to see if there was anything included that states no sale until the parents pass.

When I have all the facts I intend to call the llc preparer and discuss our options.

Linda and buddy

[mgmea]

>>I do agree that if gifted the original basis of the farm would carry over the kids.<<

Why do you think the basis would carry over? Don't you think that there was an implied aggreement that the parents would occupy the farmhouse until they died? Why do you think that this implied agreement doesn't constitute a retained interest under Sec 2036?

>>We all know if the value of the farm was enough to cause a tax due from inheritance the gov would null the sale. <<

The government doesn't have the power to "null the sale", at least not yet. What they do have is the power to properly apply Sec 2036 because there was a retained interest when the parents gifted the farm to their children. There is a question of whether that retained interest included the whole farm or just the farmhouse. There are dozens of cases regarding this that the governement won and the gifted property was included in the gross estate. For those less astute being included in the gross estate is what gives the property the stepped up basis.

Herea are a few of the court cases I'm referring too:

In Guynn v United States, 437 F.2d, 71-1 USTC Par. 12,742 (4th Cir. 1971), the decedent, an eighty year old woman, conveyed a residence to her daughter but remained in the residence without an express agreement that entitled her to do so, paid no rent to the grantee, and paid for improvements and certain expenses. The decedent's grantee, her daughter, testified that the decedent's remaining in the property was not discussed because it was understood by all involved that she would stay in the property until her death. The Fourth Circuit held that the property was included in the estate based on an implied agreement for a retained life estate.

Section 2036(a)(1) applies if there exists at the time of the transfer of property an agreement, either express or implied, that the transferor will retain possession or enjoyment of the property transferred, even if the transferor has no legally enforceable right to do so. Guynn v. United States [71-1 USTC ¶12,742], 437 F.2d 1148, 1150 (4th Cir. 1971); Estate of Rapelje v. Commissioner [Dec. 36,388], 73 T.C. 82, 86 (1979); Estate of Honigman v. Commissioner [Dec. 34,039], 66 T.C. 1080, 1082 (1976); Estate of Barlow v. Commissioner [Dec. 30,627], 55 T.C. 666, 670 (1971).

I would argue that the parents retained an interest in the farmhouse under the meaning of Sec 2036. Based on the dozen or so court cases I've read with a similiar fact situation, the tax courts would agree also I believe. I don't think that the LLC presents a problem because all it's members were their children, correct? The children could still have an implied agreement with the parents even considering the LLC because they controlled the LLC. I wouldn't argue that the parents retained an interest in the crop land that produced the rental income though.

I would suggest that the OP would carefully read at least the court cases I've outlined here. If you still think a gift is always a gift after reading them, I give up.

[RoyDaleOne]

There was some hope, but it is to complex to discuss in this forum, and I am not sure that anything can be change.

As mgmea has tried to educate the readers, a task which I turned down, I hope you comprehend and appreciate mgmea efforts.

Great job you are doing mgmea.

[OldJack]

>>For those less astute being included in the gross estate is what gives the property the stepped up basis. <<

And the reason the government won including it in the estate was because it was "gift" property where title had passed.

[mgmea]

>>And the reason the government won including it in the estate was because it was "gift" property where title had passed.<<

That's a requirement, but not the reason it was includible in the gross estate. Sec 2036(a)1 requires a lifetime transfer by the decedent for less that full and adequate consideration. A gift of a farm to the children where title has passed to the children meets this requirement. Just because the farm was gifted though won't get it included in the gross estate.

To be included in the gross estate (to paraphrase 2036(a)1): the parent (transferor) must retain the possession or enjoyment of the gifted property for a period that ends with their death. What the IRS sucessfully argued was that an implied agreement that the parents would occupy the home until they died constituted a retained possession or enjoyment of the gifted property within the meaning of Sec. 2036.

This sounds like the factual situation of the OP to me, but only for the farmhouse portion of the gift, not the cropland portion of the gift. I don't feel that the transfer to the LLC presents any problem. There are numerous court cases where the parent transferred property to a limited partnership which in turn transferred it to another limited partnership, etc.. If the parent retained their interest per Sec. 2036 after these transfers, the property was included in the gross estate. I think that the IRS would have a hard time arguing that the parents in the OP didn't retain their possession or enjoyment of the farmhouse after the transfer to the LLC because they actually lived in the farmhouse until their deaths.

Here's a link to an article that cites court cases and revenue rulings that are applicable to these situations:

http://www.bjflaw.com/docs/medicaid_tax_rules_medicaid.html

[LindaB]

For those less astute being included in the gross estate is what gives the property the stepped up basis.

(Not exactly related to this discussion)

Unless lawmakers change it, the estate tax is set to disappear in 2010, then reappear in it's original form in 2011. When the estate tax disappears in 2010, I believe the stepped up basis also disappears. So if a client inherits property in 2010 and sells it, you can't tell them their basis is the FMV at the date of death, it will be the basis of the deceased.

[ljwalters]

Final note.

All the llc distributions went into the parents account for support of parents.

Linda and buddy

[Lion EA]

OK, so everybody, even the LLC, acted as if the parents still had use and benefit.... You've convinced me to change my mind. In the estate and a step-up in basis. Hope the estate taxes don't wipe out the taxes the kids save upon the sale.