Florida Homestead: A Difficult Post-mortem Estate Tax Planning Property
As many estate planners have found, Florida homestead property can be a difficult asset to use in post-mortem planning. This is particularly true in situations where the surviving spouse, who owns a life estate in the homestead, is not the parent of the decedent’s children, who own the remainder interest in the homestead. Decisions involving the improvement or sale of the homestead often involve conflicting interests among the life tenant and the remaindermen. As difficult as these conflicts may be, federal estate and gift tax laws present an even more thorny dilemma with respect to homestead property when a sale of the homestead is contemplated by the surviving spouse and children.
In the absence of a valid devise, Florida homestead law provides that, if an individual dies owning a Florida residence titled in his name alone, and is survived by a spouse and lineal descendants, the surviving spouse takes a life estate, and the lineal descendants take a remainder interest, in the property.1 If, however, the decedent is not survived by a minor child, he can will the residence to his spouse.2 Thus, if consulted in advance, an estate planner can often avoid both the potential conflicts and the adverse estate and gift tax consequences associated with homestead property, either by having the residence titled in the names of both spouses (as tenants by the entireties) or, where there are no minor children, by having the testator devise the homestead to the surviving spouse. For this reason, difficulties involving homestead property most often arise where the decedent either dies intestate, or fails to change his will (or the title to his home) after a second marriage.
Upon the death of the owner of the homestead, the family has nine months to make two decisions which can substantially affect both the potential for conflict inherent in the co-ownership of property and the homestead’s status for tax purposes. The first decision is whether the estate should elect the marital deduction for the homestead on the decedent’s estate tax return.3 The second decision is whether the surviving spouse or the lineal descendants should disclaim the life estate in favor of the remaindermen.4
Electing the Marital Deduction for Homestead
Where a decedent is survived by a spouse and leaves a homestead as a part of a taxable estate exceeding the amount of the available applicable credit (equivalent to taxable assets of $1,000,000 for 2002), the estate can claim the marital deduction for the homestead.5 If the estate claims the marital deduction, the value of the homestead will not cause taxation in the decedent’s estate, but will be included in the taxable estate of the surviving spouse.6 Conversely, because the homestead is a terminable interest, the value of the homestead will not be included in the surviving spouse’s taxable estate if the estate does not claim the marital deduction for the homestead.7
Where the decedent’s taxable estate (including the homestead) exceeds the amount covered by the decedent’s available applicable credit, electing the marital deduction for the homestead may appear attractive, especially when the surviving spouse does not otherwise have a significant taxable estate. If the surviving spouse does have a significant taxable estate, and dies still owning the homestead, its value will be included in his or her taxable estate and may therefore generate estate taxes.8 On the other hand, if the value of the surviving spouse’s taxable estate does not exceed the amount covered by the available applicable credit, no estate taxes will be due.
When estate taxes are due in the surviving spouse’s estate, the remaindermen may argue that, according to Florida law, they are not required to contribute estate taxes attributable to the homestead.9 However, federal tax law provides the personal representative of the surviving spouse’s estate with a claim against the remaindermen for the estate taxes attributable to the homestead.10 In this situation, the Florida apportionment statute and the federal apportionment statute appear to be in conflict. It is possible, however, to interpret F.S. §733.817(2) and I.R.C. §2207A(a) consistently.
Section 733.817(2) provides that homestead property is exempt from the apportionment of taxes if the property passes to a person to whom inures the decedent’s exemption from forced sale. One interpretation is that the decedent in this situation is the surviving spouse, and that the remaindermen inure only to the first spouse to die’s exemption from forced sale and not to the surviving spouse’s exemption from forced sale. If this is the correct interpretation, then §733.817(2) affords no protection from the apportionment of taxes to the remaindermen. Even if §733.817(2) is read to provide protection to the remaindermen, there is case law to support the conclusion that I.R.C. §2207A controls.11
The tax picture is further complicated if the surviving spouse transfers, during his or her lifetime, homestead property which is also marital deduction property. Because the entire value of the homestead is included in the taxable estate of the surviving spouse, one might expect that a sale of the homestead with a retention by the surviving spouse of the entire sale proceeds would be a nonevent under the transfer tax laws. This, however, is not the case. The Internal Revenue Service has ruled that if the surviving spouse retains the entire sale proceeds, the remaindermen will be considered to have gifted their remainder interest to the surviving spouse.12
On the other hand, if the sales proceeds are divided so the surviving spouse takes the actuarial equivalent of his or her life estate and the remaindermen take the actuarial equivalent of their remainder estate, the surviving spouse will be deemed under I.R.C. §2519 to have made a gift of the remainder.13 Because the gift is one of a future interest, no annual exclusion will be allowed.14 Therefore, the surviving spouse must file a gift tax return and either pay taxes or use a portion of the available applicable credit. If gift taxes are due under I.R.C. §2519, the surviving spouse has the right to recover the gift taxes associated with the gift of the remainder interest from the remaindermen.15 It might appear, then, that the taxable gift should be no more than the value of the remainder interest less the gift taxes required to be paid by the remaindermen. Unfortunately, the Department of the Treasury has not promulgated regulations on this point.16 Further, the surviving spouse may be deemed to have made yet another gift to the remaindermen if he or she foregoes the right of recovery from them. Once again, the Department of the Treasury has reserved its authority to promulgate regulations on this point.17
The surviving spouse’s purchase of the remainder interest gives rise to a taxable gift in the amount of the greater of the value of the remainder interest or the amount paid for the remainder interest.18 Likewise, the surviving spouse’s sale of the life estate in the homestead to the remaindermen triggers the taxable gift by the surviving spouse of the remainder interest under I.R.C. §2519.19 In addition, the entire proceeds constitute taxable gain for income tax purposes because, in the sale of the life tenant’s interest alone, her basis allocation is disregarded.20 However, the surviving spouse may, if she otherwise qualifies, exclude from her income the gain from the sale under I.R.C. §121.21
The worst case may be the situation where the surviving spouse simply deeds the life estate to the remaindermen, because that transfer constitutes a taxable gift of the entire property.22 The only ameliorating factor is that the annual exclusion would be permitted because part of the gift constitutes a present interest.23 Generally, gifts under I.R.C. §2519 do not qualify for any exclusions under I.R.C. §2503(b); however, where the surviving spouse gifts the life estate to the remaindermen, a merger of the income and remainder interest for each remainderman occurs, and this combined interest qualifies for the annual exclusion.24 A deed from the surviving spouse of her life estate to the remaindermen raises the same issues raised concerning 1) the netting of the taxes against the remainder interest, and 2) whether forgoing gift tax recovery is an additional gift, as are discussed above.
It is also worthy of note that the surviving spouse cannot convey the homestead interest by employing the commonly used estate planning technique of conveying fractional interests in real estate over a period of years, in order to take advantage of fractional discounts and multiple years of annual exclusion.25 I. R.C. §2519(a) treats any disposition of “ all or part ” of a life income interest as a transfer of the entire remainder interest. In addition, because the transfer is to a family member, I.R.C. §2702 treats the value of the retained income interest by the surviving spouse as zero, and the value of the gift as the entire value of the residence, even though the only actual gift is only a fraction of the life estate.26 Furthermore, if the surviving spouse does not dispose of the entire life estate prior to death, the Department of the Treasury takes the position that the percentage of the homestead life estate retained is included in the surviving spouse’s gross estate under I.R.C. §2036(a).27
An example of the difficulty I.R.C. §§2519 and 2702 give the post-mortem estate planner can be instructive. For purposes of the example, assume that the decedent leaves a homestead worth $1,000,000, the value of the life estate to the surviving spouse is $100,000, and the value of the remainder to the two lineal descendants is $900,000. If the surviving spouse makes a gift of 10 percent of her life estate to each of the lineal descendants, there is a completed gift of $20,000 (or less if a fractional discount is taken). In addition, however, there is a deemed gift of $900,000 under I.R.C. §2519. Finally, under I.R.C. §2702, the value of the remaining 80 percent of the life estate is zero, and the transfer under I.R.C. §2519 is increased to $980,000. Thus, although the surviving spouse conveys only a 20 percent interest in the life estate, the gift tax laws deem the taxable transfer to be 100 percent of the homestead value.
Where the estate of the decedent has elected the marital deduction for the homestead and a sale of the homestead is anticipated, one way under the Treasury Regulations to avoid immediate transfer taxation is to reinvest the proceeds from the sale of the homestead into income-producing property.28 As long as the acquired property is titled in the same manner as the homestead property ( i.e., a life interest in the surviving spouse with a remainder to the original remaindermen), no taxable transfer will take place.29 Another option is to use the homestead proceeds to set up a trust that satisfies the QTIP requirements.30 In general, this would require the newly created trust to provide for an income interest exclusively in the surviving spouse. The QTIP provisions permit an invasion of principal in favor of the surviving spouse;31 However, it is unclear whether such a power would be permissible in the trust created with the homestead proceeds because no such invasion power existed in the surviving spouse’s life estate in the homestead property.
In cases where the decedent has not left a substantial taxable estate, the surviving spouse may not wish to elect the marital deduction for the homestead. The homestead value could then be used to fund the decedent’s available applicable credit. However, similar to the discussion above, if the surviving spouse retains a life estate and the estate does not elect the marital deduction for the homestead, any later conveyance of the surviving spouse’s life estate to the remaindermen will be a taxable gift.
Upon sale of the property where the estate has not elected the marital deduction for the homestead, the surviving spouse and lineal descendants can simply divide the sales proceeds according to their actuarial interests, without making taxable gifts. However, by so doing, the family may be wasting the decedent’s available applicable credit.
As an illustration of a situation where the decedent’s available applicable credit equivalent might be wasted, consider a case in which the available applicable credit is $1,000,000, the decedent’s homestead is valued at $1,000,000, and no marital deduction is elected. Assuming the decedent left all other assets to the surviving spouse, which along with assets in the surviving spouse’s own name equals $1,000,000, and the marital deduction is elected for these other assets left to the surviving spouse, no estate taxes would be due from the decedent’s estate. If the property is thereafter sold and the proceeds divided according to the surviving spouse’s and the remaindermen’s actuarial interests, the available applicable credit equivalency could be substantially misused. In the above example, a 50-year-old surviving spouse’s life estate interest would be approximately 76 percent of the value of the property (assuming an applicable federal rate of six percent). Therefore, upon the sale of the property, $760,000 would be returned to the surviving spouse’s potentially taxable estate. In this case, the surviving spouse now has $760,000 over the available applicable credit.
Disclaiming the Homestead
If the property were not homestead for descent purposes, it could be distributed in accordance with the decedent’s will or, if none, by intestate succession. Thus, the estate would benefit by either not claiming, or electing out of, homestead status for the property. Unfortunately, there is no authority to suggest that homestead status for descent purposes can be avoided by either of the means suggested above. Therefore, assuming the property is homestead, and that such status cannot be changed or avoided by action or nonaction of the parties, one way of avoiding the potential issues of coownership and the tax consequences discussed above might be to have either the surviving spouse, or all of the lineal descendants, or both, disclaim their homestead rights.
The Florida disclaimer statute specifically contemplates the disclaiming of a homestead right.32 For the disclaimer to be effective for estate and gift tax purposes, it must be accomplished within nine months of the decedent’s death in the manner prescribed in §732.801(4) and I.R.C. §2518(b). One requirement for a qualified disclaimer is that the disclaimant cannot accept any benefits of the disclaimed property.33 The IRS has ruled that a surviving spouse has not accepted an interest in a residence merely because she resided in the residence prior to the disclaimer.34
F.S. §732.801(3) treats the disclaimant as predeceasing the decedent ( i.e., the homestead owner). Thus, if both the surviving spouse and the lineal descendants disclaim the property, the property would not be homestead because both the surviving spouse and the lineal descendants would be considered to have predeceased the homestead owner. F.S. §732.801(3)(b) makes it clear that such disclaimers would not relinquish the disclaimant’s right to take by intestate succession or under the decedent’s will. Thus, if the decedent’s will provides for a QTIP trust with invasion power for the benefit of the surviving spouse, the disclaimer might allow the residence to be held in trust, giving the family the flexibility for tax planning that is not present in the homestead status.
In the intestate case, the property could be divided as a tenancy in common, allowing the estate to take the marital deduction for a portion of the value of the homestead. If the decedent’s estate so elected, the value of the balance of the homestead would qualify for the available applicable credit without it being included in the surviving spouse’s taxable estate. I.R.C. §2518 permits a surviving spouse to make a qualified disclaimer of a partial interest in property ( e.g., disclaiming the life estate in the homestead, resulting in a property interest passing to the surviving spouse). The qualified disclaimer allows the disclaimed interest to pass without being deemed a taxable gift.35
On the other hand, where the lineal descendants disclaim the homestead, and as a result of the disclaimer obtain another interest in the property either by the decedent’s will or by intestacy, the disclaimer is not a qualified disclaimer.36 For this reason, the individual lineal descendant will have made a taxable gift to the extent that he or she gives up more than he or she obtains.37 Thus, a before and after valuation of each remainderman’s interest must be undertaken before the benefit of this technique can be determined.
It may appear simpler to have only the surviving spouse disclaim his or her interest in the homestead. This would be true if the estate planner could be certain that the effect of such disclaimer would be to avoid the vesting of the remainder in the adult children. Unfortunately, estate planners today can have no such certainty. On one hand, a court might take the position that, because the homestead statute provides a vested remainder in the adult children, the surviving spouse had only a life estate at the decedent’s death and could not disclaim an interest greater than she had. This approach was taken by the Fourth District Court of Appeal in In Re: Estate of Joseph T. Ryerson, Jr., 642 So. 2d 763 (Fla. 4th DCA 1994). The holding in Ryerson resulted in the remaindermen taking a fee interest in the homestead.38
On the other hand, a court might take the position that Art. X, §4(c) of the Florida Constitution is designed to protect two classes of persons only: the surviving spouse and minor children. Because the effect of a disclaimer is to treat the property as if the disclaimant had predeceased the decedent, a court may hold that the surviving spouse’s disclaimer is effective to avoid the vesting of the reminder in the adult children. The Second District Court of Appeal took this approach in In Re: Estate of Harry Sudakoff, 681 So. 2d 1146 (Fla. 2d DCA 1995). The Sudakoff holding has the practical effect of having the homestead treated as nonhomestead property for intestate purposes. An interesting discussion of both of these cases, as well as a further explanation of the issues associated therewith, appears in an article by R. Craig Harrison in the April 1996 issue of The Florida Bar Journal, entitled “Homestead—The Post-death Spousal Disclaimer: A Cure for a Constitutionally Prohibited Devise?”
Conclusion
The estate planner must be aware of the complication of homestead property in post-mortem transfer tax planning. If homestead status cannot be avoided in the planning process while the owner is alive, the nine-month period following death is critical for making advantageous tax decisions with the surviving spouse and remaindermen. In determining whether the estate should elect the marital deduction for the homestead, the estate planner should be aware of the possible tax implications of a later transfer of the homestead. Likewise, in determining whether the surviving spouse or any of the lineal descendants should disclaim the homestead, the estate planner must conduct a careful study of the results under both Florida law and the federal tax law.
1 Fla. Stat. §732.401(1) (2001).
2 Fla. Stat. §732.4015(1) (2001).
3 I. R.C. §6075(a).
4 I. R.C. §2518(b)(2).
5 Treas. Reg. § 20.2056(b)-7(h) Ex. (1) (as amended in 1998).
6 I. R.C. §2044.
7 See I.R.C. §2033.
8 I. R.C. §2044.
9 Fla. Stat. §733.817(2) (2001).
10 I. R.C. §2207A.
11 See McAleer v Jernigan, 804 F.2d 1231 (11th Cir. 1986). The holding in McAleer, which dealt with apportionment of taxes to life insurance proceeds, is analogous to this situation and explains that the Alabama apportionment statute controls apportionment of taxes to probate assets. However, taxes on nonprobate assets, which pass by operation of law, will be apportioned according to the federal tax laws.
12 Priv. Ltr. Rul. 99-08-033 (March 1, 1999).
13 Treas. Reg. §25.2519-1(f) (1994).
14 I. R.C. §2503(b).
15 I. R.C. §2207A(b).
16 Treas. Reg. §25.2519-1(c)(4) (1994).
17 Treas. Reg. §25.2207A-1(b) (1994).
18 Rev. Rul. 98-8, 1998-1 C.B. 541.
19 Treas. Reg. §25.2519-1(g) Ex. (2) (1994).
20 I. R.C. §1001(e)(1).
21 Rev. Rul. 84-43, 1984-1 C.B. 27.
22 Treas. Reg. §25.2519-1(g) Ex. (1) (1994).
23 I. R.C. §2503(b).
24 Treas. Reg. §25.2519-1(c)(1) (1994).
25 I. R.C. §2519(a).
26 I. R.C. §2702(e) (Family members include any lineal descendant of the donor’s spouse); Treas. Reg. §25.2519-1(g) Ex. (4) (1994).
27 Treas. Reg. §25.2519-1(a) (1994), §25.2519-1(g) Ex.(4) (1994), §25.2044-1(e) Ex.(5) (as amended in 1998). But see Richard B. Stephens, et al., Federal Estate and Gift Taxation ¶10.08[1][a] n. 15 (7th ed. 1997) (arguing that the Treasury position should be challenged).
28 Treas. Reg. §25.2519-1(f) (1994).
29 Id.
30 Id.
31 Treas. Reg. §20.2056(b)-7(d)(6) (1994).
32 Fla. Stat. §732.801 (2001).
33 I. R.C. §2518(b)(3).
34 Priv. Ltr. Rul. 91-35-044 (June 3, 1991).
35 Treas. Reg. §25.2518-1(b) (as amended in 1997).
36 Treas. Reg. §25.2518-2(e).
37 I. R.C. §2518.
38 Id.
Mary A. Robison is a shareholder with the firm of Fisher, Tousey, Leas and Ball, P.A., concentrating on real estate and corporate taxation. She is certified by The Florida Bar in real estate law. Ms. Robison received her B.A. from the University of Minnesota at Duluth and her J.D. from the Duke University School of Law.
Michael W. Fisher is a graduate of The Wharton School of Finance, the University of Pennsylvania, and Stetson College of Law. He is the founding and senior partner in the law firm of Fisher, Tousey, Leas and Ball. Mr. Fisher formerly practiced as a CPA and is a member of the Tax Section of The Florida Bar, chair of the Probate and Trust Section of the Jacksonville Bar, and is board certified by The Florida Bar in estate planning and probate law.
The authors acknowledge the assistance of Krista W. Birr, an associate at the firm.
