mainderman. In the event of revocation. the property would simply become a legal interest. With respect to valuing the remainder interest. I must warn you that there is some movement in the federal courts toward requiring the purchaser of a remainder interest to pay the full fair market value of the property without discounting it for the seller's life estate (Gradow. 87-1 USTC ยง 13. 711. 1987 P-H 148. 511 (CIs Ct. 1987)). You should be aware of this problem and closely monitor all future cases. What if the purchaser can't afford the remainder interest? I'm not sure that Mrs. Jones' children could produce the amount of money necessary to implement this plan. That is one of the major drawbacks to a remainder sale. If the children have their own independent wealth. there is no problem. but 99 percent of the time this is not the
case. There are several ways of financing a purchase. First. you could exchange a promissory note for the remainder interest. The note must have an adequate stated interest and. as with all sales. must be bona fide. Don't even think aOOut monkeying around with the interest or payment or you'll destroy the whole deal. You may even consider a OOlloon note after a term of years with interest payable during the term. Another way would be to sell the remainder interest in exchange for a private annuity. However. this is not considered a good option because the remainder interest transferred is not income producing. If you really want to be aggressive. try a seIf-cancelling note. That is where the note cancels itself at the death of the seller and is not includible in the seller's estate. It's very tricky. however.
Does that mean any other type of promissory note could be includible in the life tenant's estate?
Yes. but remember that unless it is a balloon note. the principal balance will be decreasing and. hopefully. as payments of principal are made the life tenant may be making additional annual gifts or taking trips around the world to prevent asset accumulation.
28/Arkansas Lawyerl)anuary 1988
"One negative point to the remainder sale is that the remainderman does not receive a stepped up basis in the property on the death of the life tenant./I Mrs. Jones' children would be furious over a plan which recommends spending after the annual gifts. An estate tax rate of 55 percent is a great incentive to spend. What about gifting the money to the children to purchase the remainder interest? There is a danger is tying gifts to remainder interest purchases. Ever
hear of the step-transaction doctrine? The IRS can collapse a series of gifts and the purchase into one transaction: a sale without adequate consideration is the same as a gift. i.e.. you have just jeopardized your remainder interest sale since it is not a bona fide sale for full and adequate consideration in money or money's worth.
If there is no other way to finance the purchase of the remainder interest. I would recommend that your client make a gift and wait at least one year before allowing the children to purchase the remainder interest. It is called the "old and cold money rule." If you really want to get fancy. gift $600.000 to Mrs. Jones' children. then wait at least a year wld make a joint purchase of property. i.e .. Mrs. Jones purchases the life estate and her children purchase the remainder interest. What's the benefit of this? The benefit is an additional income tax benefit to Mrs. Jones who
will be able to amortize the cost of her life estate. even if the property is nondepreciable. In other words. she could purchase any investment type asset. such as stocks or buildings. and amortize the cost. There apparently is a distinction between carving out a life estate from an existing asset and purchasing a life estate (Manufacturer's Hanover Trust vs. Commissioner of Internal Revenue. 431 F.2d 664 (1970)). Speaking of income tax. what are the income tax consequences of a re-
mainder interest sale? In general. the seller of a remainder interest recognizes gain or loss by subtracting the proceeds of sale from his or her OOsis. Under the income tax regulations. the seller's basis must be allocated between the remainder interest and the life estate. Presumably the same Treasury tables which are used to value the interest may be used to allocate OOsis. If the property is sold subsequent to the sale of the remainder interest. the life tenant and the remainderman will recognize gain to the extent of the difference between their respective sales price according to the Treasury tables mentioned aOOve and their adjusted basis. Where the life tenant has the pawer of sale over OOth interests (the remainder and life estate) and the proceeds must be accounted for and preserved for the remainderman. the gain on the remainderman's interest will be taxed as if it were held in trust (Rev. Rul. 61-102. 1961-1 C.B. 245). Under other circumstances. the income tax consequence to the remainderman can also get very
complicated. What about the income tax consequences on the death of the life tenant? The law appears to be unsettled in this regard. An argument can be made that upan the death of the life tenant the receipt of the property by the remainderman results in the recognition of taxable income (Guthrie v. Cornmr. 42 BTA 696 (1940): Jones v. Commr. 40 TC 249 (1963) remanded for further proceedings. 330 F.2d 302 (3rd Cir.. 1964) on remand. T.C.M. 1966-136). One negative point to the remain-