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Jerry Reiss ASA**

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Craft and Rogers
Estate Liquidation

US v. Craft,  535 US 234  (2002)

(An Actuarial Interpretation)




With Tenants by the Entireties Property, the interest of the tax-owing spouse should be valued from the perspective of the other spouse, not an unrelated party who would never purchase that property in the first place.  The other spouse has automatic rights to half the income, full use of the property and the right of survivorship.  Valuation of the property should not ignore the IRS position of taxable income.  It helps your position and it is at the heart of the value too often ignored by attorneys defending the tax delinquent spouse. 


Operating Valuation Principle:


IRS interpretation of the Code treats each spouse as sharing one-half the income produced by the tenants by the entireties property.  The Service taxes that income as it is received.   The Right of Survivorship is automatic under Tenants by the Entireties Property.   Accordingly, it is not reasonable for that spouse to include all of the other spouse's income in valuing the property when that property will be received automatically should the other spouse die first.


Real Property:


Real Property is a unique form of property.  Generally it preserves its future value as inflations eats into it at the same time that it throws off income.  Thus while the non-delinquent spouse automatically inherits that property should the delinquent spouse die first, what that spouse really buys should the other spouse sell is the full value of that spouse’s share based on the probability that the non-owing spouse dies first.  This follows because it is received free of charge if the reverse occurs.    The interest in the property is then the full value of the property, discounted for survivorship of the non-delinquent spouse.   Whether that value can be further discounted based on state Homestead law depends on the property in question and the attendant facts.


Other than Real Property:


Funds and other liquid property also can be structured to throw off income.  Each year the principal you start with is less valuable simply because things cost more.  This is seldom true with real property.  Part of the earnings thus generated is the lost value that principal has when COLA’s work to diminish its purchasing power.  In a real sense, this income includes the distribution of principal masquerading as earnings.  The key, however, is that the Service recognizes this full portion of the earnings as income and taxes it as received.  (The Service does not do this on the appreciated portion of real property.)  Thus the Service’s position is contradictory by again recognizing its full value a second time with funds and other property when attaching  a lien (based on either a 50% interest or on the survivorship interest).  Alternatively, a future value of principal can be reduced to today’s value using a discount interest assumption.  This is a basic tenant of actuarial science long accepted by the Service.  Thus the purchase price that the non-delinquent spouse should pay equals the accumulated sum of today’s value of the property,  multiplied by the probability that the delinquent spouse survives and the non-delinquent spouse dies in that year,  further discounted by the force of inflation for each possible yearly outcome.   This is a very much lower value than a pure survivorship discount produces (as with real property discussed above).  


Other discounts may apply based on the attendant facts.  For example, if there are significant other debts (not related to tax) that could attached to the other spouse's share should the tenant by the entireties protection terminate by selling that spouse's share (thereby collapsing the tenant by the entireties protection), this would reduce further the value of the tax lien interest.   The amount of this special discount would depend strictly on the amount of property left and the amount of other debt that could attach to it.  This additional discount would not be relevant for real property when state law otherwise continues to protect the property from attachment by creditors under Homestead Law. 



Valuing The Homestead Estate (US v Rogers, 461 US 677 (1983))


The right to shelter one’s entire lifetime in the estate considers the facts of each case.  When the property in question is unencumbered, the value of the lifetime estate equals the present value of future market rent over the spouse’s lifetime, less the present value of future maintenance costs (which include taxes).  As a future market rent can be very difficult to predict, the estate could best be valued implicitly, by subtracting from today’s value of the property today’s discounted value of the future property at the time of death.  This Homestead Estate is discounted for the probability of survivorship and for the time-value of money.  When the property is encumbered, the cost of maintenance includes the yearly cost of the mortgage.  Depending on the percentage of encumbrance there could still be a sizeable homestead property estate left.


Valuing the lifetime estate is sometimes visted in litigation when the property is bequeathed to someone other than the spouse and that spouse retains the right to continue to live in that property.   A conflict develops when the new property owner wants to acquire exlusive rights to the property and would like to liquidate that spouse's property interest in the homestead.   Survivorship is not considered a discount once death of the owning spouse occurs.  The estate's value considers the above methodology and a discount only for earnings.