Many people living in Miami come from another country where Usufruct is usually suggested by their local advisors as an estate planning tool for either real estate or intangible assets. The term “usufruct” may not be common in the U.S. estate and tax planning world. Yet, it’s important to understand the unique characteristics of usufructs because they may carry hidden dangers for U.S. taxpayers.
At its core, a usufruct is a legal arrangement that allows an individual to continue benefiting from an asset, often tangible or intangible personal property, while ensuring the asset will be transferred in the future to the designated beneficiaries. Although usufructs share similarities with a life estate, a usufruct operates differently.
Like a life estate, usufructs split the property interest into two sets of rights: The owner retains the right to use the property and receives income and gains from it, while the donee receives “naked” legal title, but upon the death of the “life tenant” the donee gains full ownership.
Since we do not have usufructs in the U.S., an understanding of how the IRS will look at the arrangement is paramount, particularly because any U.S. person creating or receiving the “naked title” will have U.S. reporting obligations. Likely, the IRS has provided some guidance, and now we know that an usufruct can be considered as a “life estate,” or “trust,” depending on specific facts and circumstances.
When looking at the potential reporting obligations, we cannot forget Form 3520, where the US donee reports the gift if it exceeds $100,000. Unfortunately, many US persons ignore the reporting rules and are subject to huge penalties.
If a taxpayer unintentionally fails to report something, there are ways to correct it. The taxpayer can use IRS Streamlined Offshore Procedures or similar methods to show that they had a valid reason for their mistake and become compliant.
An important issue that arises with the obligation to report is the value of the interest received as a result of the usufruct. In that case, the donor will have to seek expert advice in the donor’s local jurisdiction to obtain an appraisal.
Additionally, if the gift involves stock of a foreign corporation or an interest in a foreign partnership, further complexities emerge. Considerations include whether the foreign corporation should be treated as a Controlled Foreign Corporation (CFC) or Passive Foreign Investment Company (PFIC) and the need to file relevant U.S. reporting forms.
Lastly, whether a U.S. recipient of a naked legal title must report income or gains from the property depends on what rights the foreign donor retains.
While usufructs are a standard tool for estate and tax planning in many parts of the world, their handling in the context of U.S. tax law can be intricate and fraught with potential pitfalls. Individuals involved in such arrangements must seek professional guidance and adhere to IRS reporting requirements to avoid any hidden tax dangers associated with usufructs. If you need assistance, you can schedule a 15-minute free call with us now.
