The IRS taxes a life estate at three separate moments: when you create it (gift tax on the remainder interest you give away), when the life tenant dies (estate tax on the property if the life tenant was the one who created the arrangement), and every year in between (income tax on rents and other property income, paid by the life tenant). All three calculations start from the same split: federal actuarial tables under Section 7520 of the Internal Revenue Code divide the property’s fair market value into a life interest and a remainder interest, and those two dollar figures drive everything that follows.1Office of the Law Revision Counsel. 26 USC 7520 – Valuation Tables
How the IRS Splits the Property Into Two Interests
Three inputs feed the valuation: the property’s fair market value (from an appraisal), the life tenant’s age, and the Section 7520 interest rate for the month of the transfer. The Section 7520 rate equals 120% of the federal midterm rate, rounded to the nearest two-tenths of a percent, and it changes every month. For March 2026, the rate is 4.8%.2Internal Revenue Service. Section 7520 Interest Rates
Those inputs run through Table S in IRS Publication 1457, which spits out a life estate factor and a remainder factor that always add up to 1.0. Multiply each factor by the property’s fair market value and you have the dollar value of each interest. The IRS uses mortality data from the most recent decennial census (currently Table 2010CM, in effect for valuations after May 31, 2023).3eCFR. 26 CFR 20.7520-1 – Valuation of Annuities, Unitrust Interests, Interests for Life or Terms of Years, and Remainder or Reversionary Interests
Older life tenants produce higher remainder factors (shorter expected lifespan, so the future ownership right arrives sooner). Lower Section 7520 rates also produce higher remainder factors (less assumed investment growth, so the future interest is worth more in today’s dollars). One point catches people off guard: the IRS does not adjust for the life tenant’s actual health. A 72-year-old with terminal cancer and a 72-year-old marathon runner get the same factor. Age is the only personal input.
A Worked Example
You’re 70 and you deed your $500,000 home to your daughter while keeping a life estate. If Table S produces a remainder factor of 0.52981 at the current rate (illustrative only), the math splits like this:
- Remainder interest: $500,000 × 0.52981 = $264,905
- Life estate: $500,000 × (1 − 0.52981) = $235,095
The $264,905 is the taxable gift to your daughter. The $235,095 you keep is not immediately taxed.
Gift Tax When You Create the Life Estate
Transferring the remainder interest is a reportable gift equal to the remainder value calculated above. Here is the rule that trips most people up: the annual gift tax exclusion ($19,000 per recipient in 2026) does not apply.4Office of the Law Revision Counsel. 26 USC 2503 – Taxable Gifts The annual exclusion only covers gifts of present interests, where the recipient can use or benefit from the property immediately. A remainder interest, by definition, doesn’t begin until the life tenant dies, so it’s a future interest and gets no annual exclusion at all.5Internal Revenue Service. Instructions for Form 709
You must report the full remainder value on IRS Form 709 regardless of the amount. In the example above, the entire $264,905 goes on the return. That doesn’t necessarily mean a check to the IRS. For 2026, the federal estate and gift tax exemption is $15,000,000, so most people can absorb the remainder gift against their lifetime unified credit without owing anything.6Internal Revenue Service. Whats New – Estate and Gift Tax But filing is mandatory, and failing to file an unreported gift never starts a statute of limitations, so the IRS can reassess the gift indefinitely.
Estate Tax When the Life Tenant Dies
This is where families get the biggest surprise. If you owned the property outright, deeded the remainder to someone else, and kept the life interest, the full fair market value of the property at your death gets pulled back into your gross estate under Section 2036. Not just the value of your life interest. The whole property.7Office of the Law Revision Counsel. 26 USC 2036 – Transfers With Retained Life Estate The IRS treats the original transfer as incomplete for estate tax purposes because you never gave up the right to use or collect income from the property during your lifetime.8eCFR. 26 CFR 20.2036-1 – Transfers With Retained Life Estate
The date-of-death value is reported on Form 706. The unified credit gets a dollar-for-dollar offset for any gift tax exemption already used when the remainder was created, so the same transfer isn’t taxed twice. With the $15,000,000 exemption, Section 2036 inclusion rarely triggers actual estate tax, but it consumes exemption that might be needed for other assets.
Section 2036 only reaches property the decedent transferred while keeping the life interest. If someone else created the life estate (your parent’s will gave you a life interest in their house with the remainder to your child, for example), the property is not included in your gross estate when you die. Your life interest simply expires.
The Stepped-Up Basis Payoff
Section 2036 inclusion comes with a significant benefit. Because the property sits in the decedent’s gross estate, the remainderman receives a stepped-up basis equal to the property’s fair market value on the date of death.9Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent A home bought decades ago for $150,000 and worth $500,000 at death produces a $500,000 basis in the remainderman’s hands. Sold the next day for $500,000, the capital gain is zero. For most families, this basis reset is the single biggest tax advantage of a life estate.
Income Tax While the Life Estate Is in Effect
The life tenant reports all income from the property on their own return. For rental property, that means gross rents on Schedule E, with ordinary operating expenses like property taxes, insurance, and maintenance deducted there.10Internal Revenue Service. About Schedule E (Form 1040), Supplemental Income and Loss The remainderman has no income tax obligation on the property’s earnings during this period.
Federal tax law also treats the life tenant as the absolute owner for depreciation. The life tenant claims the full depreciation deduction on any depreciable improvements, computed over the property’s useful life rather than over the life tenant’s expected lifespan. The remainderman cannot claim any depreciation while the life estate exists. Each year of depreciation reduces basis, and that reduction carries through to the remainderman if the property is later sold during the life estate.11eCFR. 26 CFR 1.1014-4 – Uniformity of Basis; Adjustment to Basis If the property is instead included in the life tenant’s estate at death, the stepped-up basis wipes out those depreciation adjustments.
Capital Gains If the Property Is Sold Before Death
If the life tenant and remainderman both agree to sell while the life estate is still in effect, the sales proceeds and the cost basis are split between them using the same Section 7520 factors, recalculated as of the sale date (based on the life tenant’s current age and the Section 7520 rate for the month of sale). Each party reports their own gain or loss.
Two wrinkles matter. First, the life tenant’s basis gradually decreases over time as the life interest is consumed, which can push the life tenant’s taxable gain higher than expected. Second, because the life tenant claimed all depreciation along the way, any gain attributable to that depreciation is taxed to the life tenant as unrecaptured Section 1250 gain at a maximum federal rate of 25%, rather than at the lower long-term capital gains rate. Gain above the recapture amount is taxed at standard long-term rates.
If the life tenant used the property as a principal residence for at least two of the five years before the sale, they can exclude up to $250,000 of gain ($500,000 for married couples filing jointly) under Section 121.12Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence The exclusion applies only to the life tenant’s share. The remainderman gets no Section 121 exclusion unless they also lived in the property and independently meet the ownership and use tests, which is uncommon.
Generation-Skipping Transfer Tax If the Remainderman Is a Grandchild
If the remainderman is a grandchild or anyone two or more generations below you, the generation-skipping transfer (GST) tax can apply on top of the gift or estate tax. The 2026 GST exemption is $15,000,000, matching the estate tax exemption.6Internal Revenue Service. Whats New – Estate and Gift Tax You allocate GST exemption to the remainder transfer on Form 709 when the life estate is created. Failing to allocate exemption, or running out of it, can leave the remainder interest facing a flat 40% GST tax layered on top of any gift or estate tax.
Timing the Transfer Around the Section 7520 Rate
Because the rate changes monthly, the month you create a life estate changes the tax bill. A higher rate makes the life interest more valuable and the remainder interest (the taxable gift) less valuable. A lower rate inflates the remainder value and the gift. For non-charitable family transfers, you are locked into the rate for the month the transfer occurs. For charitable remainder gifts, the IRS lets you choose the rate from the month of transfer or either of the two preceding months.13eCFR. 26 CFR 20.7520-2 – Valuation of Charitable Interests Watching the published rate before signing the deed can meaningfully reduce the reportable gift.
One Boundary Worth Flagging: Medicaid
Many families create life estates to shield a home from Medicaid claims, and the federal Medicaid rules do not line up neatly with the IRS tax rules above. Transferring a remainder interest starts a five-year lookback for Medicaid eligibility, and state estate recovery rules vary widely in whether they reach life estate interests after the life tenant’s death.14Office of the Law Revision Counsel. 42 USC 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets The IRS valuation and tax treatment described here is only one piece of the planning picture; Medicaid outcomes depend on separate federal and state law.