829 / When are gifts taking effect at death includable in a decedent’s gross estate under IRC Section 2037?

IRC Section 2037 requires inclusion in the gross estate of any interest in property transferred by the decedent if both of the following conditions are met:

(1)     Possession or enjoyment of the property can, through ownership of the transferred interest, be obtained only by surviving the decedent; and

(2)     The decedent has retained a reversionary interest in the property which, immediately before his death, exceeded 5 percent of the value of the property.

A simple example would be a transfer to an irrevocable living trust under the following terms: income to grantor’s wife for her life; property to revert to grantor if living at wife’s death and if not, property to their daughter.

Assuming that the grantor predeceases his wife and daughter, the value of the daughter’s interest – the value of the property less the wife’s life interest – is includable in the grantor’s gross estate. Obviously, the daughter had to survive the grantor in order to receive the property. And in all probability, the grantor’s reversionary interest, valued immediately before death, exceeded 5 percent of the value of the property.

The term “reversionary interest” means any possibility that the property may return to the donor or to his estate, and any possibility that the property may become subject to a power of disposition by him. The term does not, however, include a possibility that the income alone may return to the donor or his estate. Thus, retention of a secondary life estate would not constitute a reversionary interest (although it would cause inclusion under IRC Section 2036). Also, the term “reversionary interest” does not include a mere expectancy by the decedent that upon the death of the transferee he (or his estate) may reacquire the property under the will of the transferee or under state inheritance laws.¹