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Life estates and Kentucky inheritance in estate planning

tax law booksBy Nathan Vinson, attorney

English, Lucas, Priest and Owsley, LLP

Life estates have long been an efficient and simple succession planning device for those who want to leave their homes to loved ones when they die.

Here is a basic illustration of how it works:  Mom has survived Dad and owns her house outright.  She still lives in the home, which has a value of $300,000.  Mom wants to leave the home to her Son at her death.  So, Mom gives her house to the Son (the “remainder interest”) and reserves the right to live in the home during her life (the “life estate”).

A few questions and answers are outlined below to answer the most common questions we receive from clients.

Question: Does Kentucky inheritance tax apply to the gift to the Son?

Answer: Yes, but the Son is in an exempt class of beneficiaries, so there will be no Kentucky inheritance tax due from the Son upon Mom’s death. Kentucky inheritance tax is levied on three classes of estate beneficiaries at the decedent’s death: Class A, Class B, and Class C.  The highest marginal rate of inheritance tax is 16%. However, Class A beneficiaries, which consist of the decedent’s closest relatives (such as the Son in this example), are completely exempted from the tax.

Question: What if instead, Mom left the house (i.e. the remainder interest) to her favorite nephew, Hewey?  Does Kentucky inheritance tax apply to the gift to Hewey?

Answer: Yes, and Hewey is not exempt from Kentucky inheritance tax, because Hewey is classified as a Class B beneficiary.  Class B beneficiaries are taxable up to 16% on inheritances, less a small $1,000 exemption.

Pertinent to the remainder interest in real property received by Hewey (and Son, though Son is exempt from inheritance tax), KRS § 140.020 provides in part that the inheritance tax applies to:

  • Any property or interest therein, of which the decedent has made a transfer by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after death, including a transfer under which the transferor has retained for his life … the possession or enjoyment of, or the income from the property.
  • The retention of the life estate by Mom therefore acts as a “string” that keeps the value of the house in Mom’s estate at death, which then passes directly to Hewey.  Hewey will owe inheritance tax based on the value of the house, $300,000, assuming no appreciation since the gift.  If Hewey has no “liquid” assets to pay the tax, he may be forced to sell the home or, at the very least, get a loan to pay the tax.
  • Persons owning real estate in Kentucky need to keep the Kentucky inheritance tax in mind when planning to use life estates as part of their overall estate plans.  While the life estate arrangement may achieve the person’s succession planning goals, it could cause a greater inheritance tax issue than necessary.  It may be possible to minimize the inheritance tax with an alternate estate planning device, which can be explored by consulting a qualified estate planning attorney.

If you need assistance with estate planning, tax law, wills or probate, please contact attorney Nathan Vinson at nvinson@elpolaw.com or (270) 781-6500, or use our online contact form. We will be happy to help you.