Split Interest Valuation: The Devil is in the Detail

Abstract

Each item of property included in a decedent’s gross estate is valued at the time of decedent’s death. The fair market value of an item of property included in gross estate is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.” The Regulations under IRC § 2031 contain substantial guidance on application of this standard. For example, specific rules and methods apply to valuation of stocks, notes, bonds, interests in a business, and household personal effects. Complications, however, arise when an asset that is transferred is split into more than one interest. For example, if a donor seeks to gift or bequest an annuity for life, income interest for life, or a corresponding remainder interest, the value of each is dependent upon an estimation of the remaining years of life of the life interest holder. Valuation of such “partial” or “split” interests in a single asset requires knowledge of the lifespan of the relevant interest holder or the specific term which the interest will be held. The closest that we can come to determining the length of a human lifespan is an actuarial determination or estimation of the lifespan of the relevant individual. Without assistance from the IRS or the Treasury, taxpayers imposed upon by the IRC to value a partial interest in property for a person’s life must engage a professional actuary to perform a statistical calculation of risk or life expectancy for valuation purposes. However, requiring such a valuation in every instance of a gift would be expensive, inefficient and time consuming.