Estates, Trusts & Gifts
The Second Circuit held that the Tax Court clearly erred in finding that the terms of an implied agreement between a decedent and her son provided that the decedent would retain enjoyment of the entirety of a 49 percent share in a Manhattan brownstone that she had given to the son and that the entire property should remain in the estate.
Since 1989, Margot Stewart and her adult son Brandon Stewart co-owned, as joint tenants with rights of survivorship, a house in East Hampton, New York (the East Hampton property). Each summer, Margot and Brandon rented out the property, splitting the rental income evenly. They also split evenly the expenses of maintaining the property. The result was that every summer Margot and Brandon each received half of the East Hampton property’s net income.
Margot and Brandon lived on the first two floors of a five-story brownstone in Manhattan (the Manhattan property), which Margot had bought in 1968. On October 1, 1999, Margot leased the upper three floors to an unrelated commercial tenant, Financial Solutions, Ltd. The rent was $9,000 per month and the term ran through July 31, 2002.
Margot was diagnosed with pancreatic cancer in December 1999 and she began chemotherapy treatments in January 2000. On May 9, 2000, Margot and Brandon signed a deed that transferred a 49 percent interest in the Manhattan property to Brandon. Although she made the gift after she was diagnosed with cancer, Margot had discussed the gift with Brandon and an estate planner before the diagnosis. The deed provided that Margot and Brandon would be tenants in common.
After the gift was completed, Margot and Brandon continued to live together in the lower two floors of the Manhattan property. Financial Solutions continued to rent the upper three floors, but its rent payments were erratic, untimely and sometimes partial. In addition, the Manhattan property underwent thousands of dollars worth of repairs. As a result, the Manhattan property expenses were significantly higher than usual, at the same time that the income produced by the property became unreliable.
The financial relationship between Margot and Brandon underwent several significant changes during the period after the gift and before Margot’s death. While Margot continued to receive the Manhattan property rent payments from Financial Solutions, Brandon, who was receiving the rent from in the East Hampton property, stopped sharing it with Margot. Brandon also paid a small amount of the Manhattan property’s expenses, which Margot had previously paid for in their entirety. During this period, Margot paid Manhattan property expenses of $21,790.85, while Brandon paid Manhattan expenses of $1,963.
Background After Margot’s Death
Margot died on November 27, 2000. Following her death, her estate filed an estate tax return that reported the contents of Margot’s estate as including 100 percent of the East Hampton property but only a 51 percent interest in the Manhattan property. Because Margot owned only a partial interest in the Manhattan property, the estate claimed a value for the interest that was discounted significantly from a proportionate share of the entire property’s fair market value.
In December 2004, the Internal Revenue Service (IRS) issued a notice of deficiency to the estate. It contended that Margot had retained possession or enjoyment of the 49-percent interest in the Manhattan property she had given to Brandon and that the entire property was therefore part of her estate for federal tax purposes. The estate challenged the determination in Tax Court.
Tax Court Opinion
The Tax Court agreed with the IRS that Margot had retained possession and enjoyment of the whole property after her gift of an interest in it to Brandon and it upheld the IRS’s deficiency determination. The court found that the transfer of interest in the Manhattan property was a completed gift under state law.
However, the court agreed with the IRS that under Sec. 2036, 100 percent of the Manhattan property’s value was includible in Margot’s estate because she continued to live there and received all the rental income after the May 9, 2000, transfer. Sec. 2036(a)(1) provides that a decedent’s gross estate includes the value of all property interests transferred (other than for full and adequate consideration in money or money’s worth) by a decedent during her life where she has retained for life the possession or enjoyment of the property or the right to the income from the property. The Tax Court held that Margot’s retention of the property’s income stream after the property was transferred was “very clear evidence that the decedent did indeed retain ‘possession or enjoyment.’” Margot’s estate appealed the decision to the Second Circuit.
This article has been excerpted from The Tax Adviser. View the full article here.