Split-Interest Purchase of Property (SPLIT)
A split-interest purchase of property (SPLIT) is an arrangement where 2 parties agree to purchase an asset, but the one party receives a term interest in the property, i.e., the right to use the property for a lifetime or a term of years, or to receive the income from the property for the term. The other party receives a remainder interest, where the 2nd party will receive the property entirely when the 1st party dies. SPLITs are used as an estate planning tool to reduce gift, estate, or generation-skipping transfer taxes. However, IRC §2702 has reduced the value of SPLITs for related persons, where IRC §2702 values unqualified term interests at 0 for federal gift tax purposes if the value of the interests is not based on IRC §7520, which stipulates that the value of any interest for a term of life or years must be based on actuarial tables published by the IRS. Otherwise, the entire property will be subject to gift, estate, or generation-skipping transfer tax.
The term interest is purchased by the wealthier, older buyer, who is usually a parent or grandparent. Because the value of the interest in the property depends on the present value of the interest, the term interest will be the most expensive, since the term holder will benefit from the property immediately. The purchase price of the remainder interest will be much less, since the present value of the remainder interest will be much lower. Because the value of both interests depends on the life expectancy of the term holder, the percentage share of the purchase price for each interest will depend on IRS valuation tables. Obviously, the person receiving the life estate in the property is usually the older person, or one who is likely to die sooner, since the remainderman will not receive the property until the death of the term holder.
Because the remainder interest passes by contract, it is not subject to probate nor can creditors of the term holder claim the remainder interest in the property. The property will not be included in the estate of the term holder nor will it be subject to generation-skipping transfer taxes, since the property passes by contract rather than by bequest. Additionally, heirs cannot contest the transfer of property to the remainderman. SPLITs can also be used to avoid ancillary probate of real estate located in other states, since the property will pass by contract to the remainderman.
The purchase price for each interest is based on government valuation tables that stipulate an actuarial value for the term interest and for the remainder interest. The term interest buyer should not provide funds to the buyer of the remainder interest for the purchase of the remainder interest. The value of the term interest is equal to the present value of the expected income. The property cannot be sold without the consent of both parties, and the rights of the term interest holder and the remainder holder are stipulated by state law.
If the parties are related, as defined under IRC §2702, the purchase of the property will be treated as a gift from the person who has the term interest to the remainder person, equal to the fair market value of the property minus the consideration paid by the remainder person. This gift tax treatment can be avoided if the term holder receives a fixed annuity payment or a fixed unitrust percentage, using the same rules for grantor-retained annuity trusts (GRATs) and grantor-retained unitrusts (GRUTs), which are exceptions under §2702. If the term holder’s payments are equal to the actuarial value of the annuity or unitrust payments, then there would be no taxable gift of the remainder, since both the value of the payments and the consideration paid by the remainder person can be subtracted from the property's value.
However, if the property is tangible property, where the term holder will not receive any income, then the value of the term interest is what a willing buyer would pay from a willing seller who are unrelated to each other. In these cases, actuarial tables are not used, or even appraisals. Rather, comparable sales or rentals are determinative. The remainder interest should also not be includable in the estate of the term holder, since the term holder did not transfer the remainder interest.
It is important to ensure that both parties pay full consideration for their share of the property. If the term interest holder pays for most or all the property, then it will be includable in the term holder’s estate under IRC §2036.