Amortization of life estates and term interests.

• Author: Bezzarro, Susan L.

A term interest in property is defined under Sec. 1001(e)(2} to fitclude a life interest in property, an interest in property/or a term of years and an income interest in a trust.

When a term fitterest in property is created, there may be an opportunity to write oil the cost of the interest even if the property is not otherwise depreciable. When the underlying property is depreciable, the term holder may be able to accomplish a faster write-off of its cost than would be available under normal depreciation rules. However, if the term holder and the remainderman are related, special rules may apply to deny this amortization entirely and impose an odd set of basis calculation rules.

Prior to the Revenue Reconciliation Act of 1989, any purchaser of a term interest could amortize the cost of his interest over his life expectancy or the term of years of the interest on a straight-line basis. However, an individual who divided an existing property and kept a term interest could not amortize the retained interest. Example 1: A and B are unrelated individuals who purchase a $100,000 security. A purchases a 10-year interest in the security for $60,000 and B contributes $40,000 for the remainder interest. A may offset his income from the security by $6,000 of amortization of cost each year. After the term interest has expired, B succeeds to the property with a basis of $40,000; this amount may not be amortized but is B's basis for purposes of computing gain or loss on disposition. If A dies during his term leaving unamortized basis, the remaining unamortized basis is lost.

In Example 1, if the underlying property is depreciable, there is a twist. A conservative approach would be for the term holder to depreciate the basis in the remainder at the same time he is amortizing his interest. An aggressive approach would be to depreciate the entire cost of the property and amortize the term interest all at the same time [up to the property's total cost).

While these rules continue to apply to property interests created between unrelated parties, the rules have been modified when the term holder and the remainderman are related. For such term interests acquired or created after July 27, 1989 in tax years ending after that date, Sec. 167(e) provides that no amortization of the term interest is allowed. Instead, a calculation of the amortization is made on an "as if" basis. The amortization, while not a deduction to the term holder, becomes an addition to the...