United States: Estate Planning: Where usufruct and US tax laws collide

Last Updated: October 24 2018
Article by Matthew Ledvina

Usufruct is typically used as an advantageous estate planning technique in Europe and in particular in France. However, in situations where US tax laws come into play, the advantages of using it can be diminished or negated, depending on the specific details of the arrangement and situation.

Ownership in two parts: Usufruct and 'bare' ownership

Usufruct is similar to the concept of the life interest or life estate you typically find in common law jurisdictions. In the civil law system ownership can be split in two parts:

  • Usufruct – the word 'usufruct' comes from the Latin words 'usus' - to use - and 'fruct' - to enjoy. The usufruct holder has the right to use and enjoy the property during their life time (or for a specific period of time). He is entitled to receive the rental incomes or interests and dividends generated by the asset. The usufruct holder is similar to a 'life tenant' (for real estate property) in the common law system.
  • 'Bare' or 'Naked' ownership – the "bare owner" holds the title of the property and has full rights to the property once the usufruct right ends (upon death or the end of its term). He is the one entitled to sell the asset and will benefit from the growth and capital gain deriving from it.

Depending on the nature of the asset which ownership is split between usufruct and bare ownership, there may be a need for an agreement between the life-tenant and the bare owner in order to govern the rights or each of them.

Usufruct – treated as a trust or life interest in the US?

The US Internal Revenue Service (IRS) has held in several rulings that a usufruct relationship between the usufruct holder and the bare owner is comparable to the relationship between a life tenant and a remainderman under common law, and not as a trust. However, in at least one case, the IRS classified the relationship as a trust because the usufruct holder had the duty to conserve and protect the estate for the bare owners.  So although the usufruct relationship is generally treated as one between a life tenant and a remainderman, the US tax classification will be based on all relevant facts and circumstances.

Estate planning scenarios involving usufruct

While there are a wide range of scenarios involving the existence of or creation of a usufruct interest, two common situations arising from estate planning in France are: 

1. The full property owner (of both usufruct and the title) keeps the usufruct right during their lifetime but transfers the bare ownership.

For example, while still living, parents gift the bare ownership of property to their children, while keeping the usufruct right for themselves (i.e. they can possess, enjoy, and derive an income from the property during their lifetime). By transferring only the bare ownership, and keeping the usufruct interest, less gift tax is paid at the time of the transfer because the value of the bare ownership is necessarily lower than the value of the "full ownership". Upon the parent's death, the usufruct right is then "passed on" to the children without inheritance tax imposed. Technically, the usufruct of the parent just extinguishes by death (without triggering any taxation) and the rights of the children are freed from the usufruct of their parent so that they can enjoy the full ownership of the asset.

When this estate planning technique comes into contact with the US tax system, the tax benefits may be negated. It also may trigger additional gift tax reporting. So the following situations should be looked at very closely:

  • US persons domiciled in France should be careful about the usual tax planning that their French notary could suggest on their worldwide assets;
  • French nationals transferring their tax residence and may be their domicile to the US should also carefully review their tax planning;
  • The contact between the US tax system and the French tax system will also arise for US residents and domiciled owning French properties or French residents owning US properties.

2. The death of the full property owner creates an usufruct interest for one party and bare ownership for another.

Using real estate property as an example, the usufruct right is similar to the creation of a life tenant in common law jurisdictions following a death of the decedent. For example, one spouse dies and an usufruct right is created for the surviving spouse (due to a will, a previous agreement or just by application of law) while the bare ownership is transferred to the children. This technique is effective from a tax perspective in France where there is a spousal exemption for the transfer of the life-tenancy while the children will enjoy a reduced taxable basis for the computation of the inheritance taxes. The surviving spouse is able to enjoy and derive an income from the property, while the children own the title. Upon the surviving spouse's death, the usufruct interest will extinguish and the children will have full ownership of the property.

In this situation in the US, the value of the decedent's taxable estate might not be reduced based on the usufruct interest as would generally be the case in civil law jurisdictions. This could affect, for example:

  • a decedent who was domiciled in the US out of his French properties or
  • a US citizen domiciled in France at the time of death.

If both the usufruct holder (life tenant) and the bare owner (remainderman) come together to sell property burdened by a usufruct, if the sale proceed is split between the life tenant and the bare owner, the life tenant can realize a gain (loss) attributable to the disposition of the life or income interest while the remainderman can realize a gain (loss) attributable to the disposition of the remainder interest.

When usufruct meets US tax law

When a property exists with a usufruct right, there may be unintended consequences when the situation comes into contact with US tax law due to decedents or beneficiaries residing in the US

  • US Gift Tax - For a US person, the gift tax applies to transfers of tangible, intangible, or real property, regardless of its location.  By contrast, for a non-US person, the gift tax applies only if the property is situated in the US and it is tangible or real property. Gift transfers of intangible property (e.g. stock or debt obligations) by a non-US person are not subject to the US gift tax. Accordingly, a non-US person may make a complete gift of US securities to the naked title holders while reserving an income interest as a usufruct holder and not be subject to the US gift tax because the securities are intangible property. By contrast, a complete gift transfer of title in a US real estate property by a non-US person should result in gift tax consequences even though the donor has only a usufruct right. In practice it means that French tax resident individuals owning a property in the US should think carefully before implementing a traditional French estate planning and gifting the bare-ownership of such property to their children while keeping the usufruct during their life.
  • US Estate Tax – In general, the estate for tax purposes includes the value of all property in which the decedent had an interest (or held certain powers) at the time of death.  For a non-US person decedent, the gross estate includes only property situated in the US  (US property includes stock issued by US corporations regardless of where the share certificates are located). Estate tax rules in the US can lead to problems for donors who have moved to the US and already have a usufruct arrangement in place because the value of the entire property (both the usufruct interest and the naked title) may be included in the estate. This could be the case for French individuals transferring their tax residence to the US

Given the different rules for gift and estate taxes, a tax trap awaits the unwary: while a gift transfer by a non-US person donor of US intangible property (e.g., US stock) with a usufruct right should not incur the US gift tax, a retained life estate or income interest in such property would very likely cause it to be included in the donor's US gross estate unless otherwise stated by a double tax treaty. Fortunately, a French tax resident holding US intangible property would be protected from US estate tax thanks to the French-US double tax treaty covering gifts and inheritance taxes.

  • US information reporting requirements - A US person who receives or holds the naked title to usufruct property located outside the US or from a non-US person may have several US information reporting requirements, including Forms 8938 and 3520.
  • US reporting requirements for financial accounts and assets (FATCA) – if a US person holds a usufruct account at a Foreign Financial Institution (FFI), the US person is required to report the account in FBAR reporting and the FFI may be required to report the account to the IRS or home country tax authority under FATCA.

A final note: PFICs and usufruct

Absent planning or special elections, a US person owning stock in a passive foreign investment company (PFIC) is subject to harsh tax rules.  Notably, certain distributions from PFICs and gains from the disposition of PFICs are taxed at the highest ordinary income tax rates with an added interest charge. 

Certain assets acquired from a decedent obtains fair market value basis (step up basis), which can reduce the gains realized by the heir or other recipient when he later sells them.  However, there is no step up basis in property unless, as relevant here, (i) the property is acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent or (ii) the property is included in the decedent's gross estate for US federal tax purposes.  Usually condition (i) does not occur in the case of a usufruct because the whole point of it is to avoid death transfers.  And, in the case of PFICs, condition (ii) does not occur if the decedent is not a US person.  Let's imagine a French tax resident owning a French holding company. He would likely make a French traditional estate planning by gifting bare-ownership of his shares while keeping the usufruct during his life. Now let's imagine that one of his children is a US tax resident, upon his parent's death, he could face PFIC issues in the US without any step up basis.

To obtain step up basis, the PFIC may need to be held through a company that can make a special election to be classified as a flow-through entity, e.g., a disregarded entity or partnership, for US federal tax purposes.  The election is made after the decedent's date of death.  With an appropriate structure and proper timing, US person heirs could not only obtain step up basis in the PFIC but also avoid the so-called controlled foreign corporation regime with respect to the holding company (if it is non-US).

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Anaford Attorneys
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Anaford Attorneys
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions