Contents of Main Description

Addressing Ownership Issues during the Term of the Life Estate
   Taxes
   Insurance; Casualty
   Standards of Care; Compliance with Laws
   Liability; Indemnity
   Condemnation
Coupling a Conservation Easement with a Reserved Life Estate
Reversionary Interest
The Transaction
   Title
   Realty Transfer Tax
Tax Concerns
   Personal Residence or Farm Only
   Value of Contribution
   Claiming Deduction
   Property Subject to Mortgage
   Reservation for Life of Owner and non-Owner
   No Restrictions for Benefit of Owner

Many landowners have no interest in selling or donating their land to a conservation organization so long as they or their family members can continue to enjoy its natural, scenic and recreational resources.  A conservation organization that wants to guard against the property falling into the hands of an owner who does not share those conservation values has several options to discuss with the present owners:

• Negotiate a right of first purchase  if the land is ever to be sold outside the family. 
• Establish an understanding with the owners that they will include in their will a gift of the property in whole or in part. (Note that if there is no consideration, or legally valid substitute for consideration, the owners' promise to make a testamentary gift may not be enforceable if, for some reason, the gift is not included in the will.) 
• Transfer the land to the conservation organization subject to a reserved life estate.

A transfer of the land to the conservation organization subject to a reserved life estate will end all uncertainty as to the future ownership of the land. However, there are two major categories of concern with respect to the division of present and future interests:  (1) responsibilities for the burdens of real estate ownership arising during the term of the present interest; and (2) achieving desired tax benefits while avoiding a number of unintended negative tax consequences.

Addressing Ownership Issues during the Term of the Life Estate

When a conservation organization accepts ownership of a remainder interest in real property, it accepts ownership in its condition as of the date the present interest ends -- usually the death of the grantor.  If the conservation organization wants assurance that the property will be kept in accordance with certain standards, those standards must be set forth in a legally enforceable agreement (a "life estate agreement") with the holder of the present interest in the property (called a "life tenant").  The concerns of the holder of the remainder interest (called a "remainderman") during a life estate are similar to those of a landlord during a tenancy for a term of years -- taxes, insurance, repair and maintenance, casualty, condemnation and other concerns discussed below in this section. 

Taxes

Unless otherwise provided by agreement, the life tenant has no legal duty to pay real property taxes so as to preserve the interest of the remainderman in the property.  If the remainderman advances funds to pay current real estate taxes so as to preserve the property from exposure to a tax sale, the rule developed by case law over the centuries is that there is no implied duty on the part of the life tenant to reimburse the remainderman. A fundamental reason to have a life estate agreement is to allocate responsibility for payment of taxes and provide a remedy for failure to discharge that obligation before penalties and interest begin to accrue.  A tax sale will divest the interest of both the life tenant and the remainderman; accordingly, to preserve its remainder interest, a conservation organization must be sure that the life tenant is paying taxes in full and on time and, if not, must be prepared to advance funds to discharge that obligation and exercise its collection remedies set forth in the life estate agreement.  Because the deed subject to life estate will show the conservation organization as grantee, taxing authorities may issue bills to the holder of the remainder rather than life tenant, which is another reason to clarify in the life estate agreement who has responsibility for payment regardless of the billing.

Insurance; Casualty

Unless otherwise provided by agreement, the life tenant has no obligation to provide or pay premiums for policies of insurance or otherwise provide funds to repair or rebuild improvements within the property after a fire or other casualty.  The life tenant has no duty to repair or rebuild for the benefit of the remainderman.  If improvements within the property are of value to the conservation organization holding the remainder interest, the life estate agreement can allocate responsibility for provision of insurance and the right or obligation to repair, restore and rebuild after a casualty. 

Standards of Care; Compliance with Laws

If the conservation organization expects the real property to be maintained in accordance with certain standards, those expectations must be set forth in a life estate agreement to be enforceable against the life tenant.   Restrictions on construction, demolition or relocation of improvements may be important to preserve conservation values for the future.  Certain activities and uses, such as tree cutting, soil disturbance, release of hazardous substances, and others, must be prohibited or regulated if and to the extent the effects of these activities and uses diminish the conservation value of the remainder interest.  Before accepting a remainder interest, the conservation organization should perform the same due diligence inspections that a reasonably prudent purchaser would perform.  If the property is not in the same condition and in compliance with applicable laws as of the end of the term of the life estate, the life estate agreement should provide an obligation of the owner (on behalf of himself and his executors, personal representatives and assigns) to remedy the non-compliance.

If the intent is to conserve the property for all time, placing a conservation easement  on the property prior to donating a future interest is likely to have better outcomes for the donating landowner and conservation organization than simply placing restrictions in the life estate agreement. See “Coupling a Conservation Easement with a Reserved Life Estate”.

Liability; Indemnity

The conservation organization, as holder of the remainder interest, has no duty of care to keep the property in a reasonably safe condition during the life estate.  However, since the public record will show the last deed of record to conservation organization, as grantee, the conservation organization can anticipate the probability that it may be named in a claim pertaining to the condition of the property during the life estate.  For that reason, it should seek an indemnity agreement from the life tenant so that the conservation organization does not have to incur any expense to defend claims for which it has no liability.

Condemnation

If the property is condemned in whole or in part during the life estate, the remainderman will have a claim for the taking of its interest as will the life tenant.   The life estate agreement can require the parties to cooperate with each other to obtain the full fair market value of the property taken and allocate the proceeds in accordance with a mutually agreeable formula.

 

Coupling a Conservation Easement with a Reserved Life Estate

If the intent is to conserve the property for all time (i.e., if the landowners and conservation organization agree that the conservation values of the property should be protected both during the term of the life estate and thereafter) and the property has significant conservation value, it likely makes sense to couple the use of a reserved life estate with a conservation easement.  By donating a conservation easement, the landowners would place certain restrictions on the property to protect its conservation values, presumably restrictions similar to those that would have been in the life estate agreement anyway. For this donation, the landowners could receive a federal income tax deduction. On top of this, by subsequently donating the future interest in the land, the landowners could receive a second federal income tax deduction. The landowners would give up nothing more than they would by conveying the future interest alone, and they would potentially receive a greater federal income tax deduction.

 

Reversionary Interest

A deed conveying a remainder interest to commence after expiration of a life estate can also create a reversionary interest to commence upon the occurrence of some condition that would accelerate the change of ownership before the death of the life tenant.  For example, an occurrence triggering the change of ownership might be the permanent removal of the life tenant from the premises or the violation of certain terms of the life estate agreement.

 

The Transaction

Title

Prior to acceptance of a remainder interest, the conservation organization should obtain a commitment to insure its title to the property vested by the deed subject to reserved life estate.  The life estate will be shown as an exception to title.  No mortgages or other liens should be permitted as exceptions unless there is an agreement between the conservation organization and the life tenant as to who is obligated to continue payments and remedies for failure to do so.  The donation of a remainder interest to a conservation organization or other charitable organization under and subject to an outstanding mortgage is considered a bargain-sale for federal tax purposes.  After the division of ownership into a present interest and future interest by the deed, the remainder is not affected by a subsequent mortgage or other lien upon the interest of the life tenant in the property so long as the holder of the remainder does not join in, subordinate to, or otherwise agree to recognize the rights of mortgage holder in the property after the termination of the life estate.

Realty Transfer Tax

Realty transfer tax is due upon recordation of a deed transferring a remainder interest in real estate.  The transfer tax regulations published in §91.165 of the Pennsylvania Code provide for the publication in the Pennsylvania Bulletin of tables to establish the fair market value of the remainder interest based upon the factors used by the Internal Revenue Service to determine same.  Of course, if the transfer is to a conservancy recognized as a charitable organization under 501(c)(3) of the IRC, then the transfer will be exempt under §(18).

Tax Concerns

Personal Residence or Farm Only

The general rule of the federal income tax code set forth in IRC §170(f)(3)(A) is that a contribution of a partial interest in property is NOT deductible unless an exception applies.  One of these exceptions is familiar to conservation organizations -- a qualified conservation contribution -- commonly referred to as a conservation easement.  Another exception found in IRC §170(f)(3)(B)(i) permits a deduction for the contribution of a remainder interest in a personal residence or farm to a charitable organization recognized under IRC§501(c)(3).  A "farm" is defined as "any land used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock" together with the improvements thereon.  The term "livestock" includes "cattle, hogs, horses, mules, donkeys, sheep, goats, captive fur-bearing animals, chickens, turkeys, pigeons and other poultry".    A charitable contribution of a remainder interest in forest or other open space land not actively used for agricultural purposes does not fall within this exception from the general rule of no deductibility for the contribution of a partial interest in property.

Value of Contribution

The value of the charitable contribution of a remainder interest in a personal residence or farm is equal to the net present value of the charitable remainder interest.  IRC §1.170A-12 provides guidance as to how that value is to be computed based on the factors briefly listed below:

• The fair market value of the property (including improvements) on the date of transfer.
• The fair market value of depreciable improvements attached to or depletable resources associated with the property on the date of transfer.
• The estimated useful life of the depreciable improvements.
• The salvage value of the depreciable improvements at the conclusion of their useful life.
• The measuring term of the agreement which, if measured by the life of one or more individuals, is measured from the date of birth of the individuals. This factor determines the period of time between the transfer and the end of the life estate.
• The "Applicable Federal Midterm Rate" in effect for the month of transfer or during either of the two preceding months.  This factor determines the discount rate that will be applied to reduce the value as of the end of the life estate to its present value as of the date of transfer.

A detailed discussion of the factors and the computation is outside the scope of this summary.  Persons interested in donating a remainder interest to a conservation organization should seek advice from a qualified tax professional.

Claiming Deduction

Assuming that the personal residence or farm is property held long-term by the donor and is donated to a conservation organization recognized under §501(c)(3) of the IRC, then the present value of the remainder interest is deductible against 30% of the donor's adjusted gross income the same as any other charitable donation.  Any unused portion can be carried forward for up to five years.  The value of the remainder interest must be supported by a qualified appraisal if the deduction claimed exceeds $5,000.

Property Subject to Mortgage

Transfer of a remainder interest in a property subject to a mortgage is treated as a bargain-sale for tax purposes and gain or loss may be recognized upon the transfer in accordance with applicable provisions of the IRC.  These provisions include both the bargain sale rules set forth in IRC §1011(b) and applicable rules for exclusion of gain on sale or exchange of personal residence set forth in IRC §121.  The recognition of gain may result in adverse tax consequences to the donor, a discussion of which is outside the scope of this discussion.  Donors should seek the advice of a knowledgeable tax professional.

Reservation for Life of Owner and non-Owner

Sometimes an owner wants to reserve a life estate not only to himself for his life but to another for his or her life as well.  Reserving a life estate for the benefit of a non-owner is a gift that may have potential gift and estate tax ramifications that should be discussed with tax and estate planning professionals.

No Restrictions for Benefit of Owner

To qualify for tax deductibility, the gift of the remainder interest must be unfettered and unconditional.  For example, the life estate agreement cannot require the remainderman to join in a sale of the property if desired by the life tenant.  Under Revenue Ruling 77-305, the contribution was disallowed even though the remainderman was entitled, under the life estate agreement, to share proportionately in the proceeds of sale.  If the owners had contributed an undivided interest in fee simple instead of a remainder interest, the result would have been different which reinforces the critical importance of seeking professional assistance in planning a contribution of a partial interest in property to charity.

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