February 2008 Vol. 53, No. 8 Real PRoPeRty

February 2008, vol. 53, no. 8
Real Property
The newsletter of the ISBA’s Section on Real Estate Law
Editor’s note
By Gary R. Gehlbach, Editor
Problem with proposed change to
Rules of Professional Conduct
T
he ISBA/CBA Joint Committee
on Ethics 2000 has developed
and presented new Rules of
Professional Conduct to the Illinois
Supreme Court. The general consensus is that these Rules are a significant
improvement to the present Rules and
that they appropriately address the
changing nature by which legal services
are rendered.
However, Rule 5.7 as proposed
would arguably create a potential conflict between the attorney and his or her
client in matters that have historically
constituted the practice of law when
undertaken by an attorney. For example, Rule 5.7(b) defines “law-related
services” as “services that might reasonably be performed in conjunction with
and in substance related to the provision of legal services,” and Comment
no. 9 specifically includes within its
scope “real estate counseling.” Most of
us who represent clients in real estate
transactions occasionally engage in real
estate counseling.
The problem, notes Michael Rooney,
In this issue
...... 1
•Editor’s note
•Should a utility company be
responsible for property taxes
...... 2
on a utility easement?
• Life Estate Transaction legal
considerations
• 2007 Amendments to ILCS
770 60/23 – The Public Lien
Act – Public Act 095-0274
•Supreme Court settles
dispute between appellate
districts
...... 5
...... 9
...... 11
who serves as an advisor to title insurance companies and is a frequent
lecturer and writer on matters of legal
ethics and professional responsibility,
is twofold. Proposed Rule 5.7 would
relegate to the category of “law-related
services” many of the functions that
real estate attorneys routinely perform
as part of our practice of law, including
drafting leases and contracts, preparing
trusts and wills, forming corporations
and other legal entities, providing tax
advice, and counseling our clients on
real estate matters. And when paired
with proposed Rule 1.8, the delivery of
a law-related service is accomplished
when an attorney enters into a “business transaction” with a client, which
requires disclosure and consent, advising the potential client that others
provide this service as well, and that
the client should consult with another
attorney before agreeing to enter into a
business transaction with us.
The Real Estate Law Section Council
at its December meeting considered Mr.
Rooney’s concerns and adopted a proposal that would delete the definition
of “law-related services” from proposed
Rule 5.7. This proposal was sent to the
ISBA Board of Governors and approved
at the Board of Governors’ January
meeting.
The absent buyers
Hopefully this isn’t a growing trend,
but twice in the last month I have
appeared at a closing representing the
seller, but neither the buyer nor anyone
with power of attorney for the buyer was
present or intended to be. In both cases
the buyer’s money had been timely
wired, and in both cases the real estate
broker was there. Neither the buyers
nor their representatives (in one of these
cases, the buyer was using an attorney, but in Pennsylvania, not licensed
to practice in Illinois) understood that
either the buyer or a duly authorized
agent would be required to sign the
Settlement Statement and other documents. One of these closings was thus
delayed over a weekend to allow the
buyer to sign documents that were sent
via overnight courier to him. The other
closing was delayed for several hours.
In neither case, even though I have
closed thousands and thousands of real
estate transactions, did it occur to me to
make sure that the buyer or an authorized agent was available to sign documents, or perhaps needed to do so in
advance of the closing. I assumed that
everyone knew this (I guess that’s what
happens when one “assumes”).
The second generation land trust
beneficiaries
A reader from Evanston poses an
interesting question. The parents hold
title to their residence in an Illinois
land trust, with a bank acting as trustee.
Mom and Dad die, and Brother and
Sister “inherit” the parents’ beneficial
interest in the land trust. Brother moves
into the house and proceeds to trash it,
pays no rent, and ignores the real estate
tax bills. What is Sister’s recourse?
Assuming that the 20 or 21 year term of
the land trust has not expired, what can
Sister do?
First, there is a lesson here for those
of us who engage in estate planning.
Rather than a general dispositive provision in the parents’ wills or trusts,
their estate plan probably should have
required the executor or successor
trustee to direct the land trustee to deed
the property to the two siblings. If, however, the parents’ beneficial interests are
left equally to Brother and Sister, neither
has a right to initiate a partition action.
Henry Kenoe, the late Illinois land
trust guru, suggests that courts of equity
have the authority to deal with extreme
situations in land trusts. Citing Regas v.
Real Property
Danigeles, 54 Ill.App. 2d 271 (1965),
Mr. Kenoe, in IICLE’s Kenoe on Land
Trusts (1981), proffers that in circumstances in which the continuation of
the beneficiary relationship is impossible, the court will terminate it. Query
whether the situation presented by the
Evanston attorney is extreme enough.
The postponed or
terminated closing
Mary Umberger, in her column
in the “Real Estate” section of the
Chicago Tribune for Sunday, January
27, 2008, cites an unnamed study
that “found that one-third of homepurchase transactions in September,
October and November were
postponed or went south.” Wow!
Fortunately, this hasn’t been my experience.
This issue
Have is ever occurred to you that
perhaps public utility companies
should be paying real estate taxes on
easements for gas storage and utility
easements? Attorney Francis O’Malley
notes that the Illinois Supreme Court
recently addressed this issue, and you
will find his article informative.
Legal life estates are fraught with
problems and our office’s practice
is to do our best to avoid them.
Nonetheless, many old legal life
estates still exist, and our clients are
the beneficiaries or at least in line to
eventually be a beneficiary (depending
on survivorship). How should we deal
with the myriad of issues that arise in
the context of life estates? If you’ve
ever had this issue or may in the
future, you will enjoy and save Alan
Stumpf’s article on this topic.
Julius Shapiro chaired a subcommittee of the Construction and Mechanics
Lien Committee of the Chicago Bar
Association and was instrumental
in developing amendments to the
Mechanics Lien Act. He shares his
insights.
Finally for this issue, I am including
an article on a very recent decision by
the Illinois Supreme Court, settling a
dispute between the appellate districts
about whether a real estate tax proration done at closing merges with the
deed or survives the closing.
- Gary R. Gehlbach
Should a utility company be
responsible for property taxes on
a utility easement?
By Francis W. O’Malley *
M
ost properties are encumbered by easements of
utilities or regulated
entities, such as gas, power or telecommunications easements. Who
should be responsible for the property
taxes on these gas storage and utility
easements—the land owner or the
utility company? Also, do such easements add taxable value to property?
The Illinois Supreme Court recently
addressed these issues in Kankakee
County Board of Review v. Property
Tax Appeal Board et al., No. 102318,
2007 WL 1650564 (Ill. June 7, 2007).
The taxpayer in this case was
Natural Gas Pipeline Company
(“NGPL”), which owned a 76 acre
parcel in Kankakee County (“subject
76 acres”) on which it operated a
multi-building compressor station. The
compressor station was used in the
transportation of natural gas as part
of a cross-country pipeline that was
located 16 miles away. The compressor station was also used in the storage
of natural gas in two underground
storage reservoirs. These “reservoirs”
were two separate layers of naturally
occurring porous rock formations lying
1,700 and 2,400 feet below the earth’s
surface. The storage areas lay below
Real Property
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Editor
Gary R. Gehlbach
215 E. First St., Ste. 100, P.O. Box 447
Dixon, IL 61021-3166
Associate Editor
Patrick L. Quist
Chicago Title Insurance
505 E. North Ave.
Carol Stream, IL 60188
Managing Editor/Production
Katie Underwood
[email protected]
Real Estate Law Section Council
Steven P. Zimmerman, Chair
Gary R. Gehlbach, Vice Chair
Marylou L. Kent, Secretary
Ted M. Niemann, Ex-Officio
Aurora N. AbellaAustriaco
Greg C. Anderson
Diana N.
Athanasopoulos
Steven B. Bashaw
Richard B. Caifano
Joel L. Chupack
Deborah B. Cole
Roberta C. Conwell
Kenneth E. Davies
Robert J. Duffin
Michael L. English
Leslie A. Hairston
Elmer C. Hawkins
Ronald K. Hoskin
Myles L. Jacobs
Carol L. Klima-Martin
James R. Lauterbach
Ellis B. Levin
Samuel H. Levine
Brian P. Liston
Deborah S. Loos
Thomas C . McGowen
Mary E. McSwain
Margery Newman
Jenny H. Park
Tracie R. Porter
Paul J. Prybylo
C. Kent Renshaw
Ralph J. Schumann
Ethel Spyratos
Jack H. Tibbetts
Phillip R. Van Ness
James K. Weston
Michelle M. Wiedman
Mauro Glorioso, Board Liaison
Selina S. Thomas, Staff Liaison
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Vol. 53, No. 8, February 2008
Real Property
approximately 15,600 acres of surface
land that surrounded and included
NGPL’s 76 acres. The taxpayer owned
only that portion of the storage area that
lay directly below the subject 76 acres.
It did not own any of the surrounding
15,600 acres of surface land or the storage areas that lay below them.
NGPL injected natural gas into the
storage areas through a system of pipes
that connected the pipeline to the
compressor station, and the compressor station with 281 wells that reached
the storage areas at different points
throughout the 15,600 acres.
In the early 1950s, NGPL secured
easements from the owners of the
land included in the underground
storage area so that it could install
and operate the wells and pipes used
in its storage system. The easements
read in part, “This instrument made
this (date) by record owner (name of
the fee land owner) herein referred
to as Grantors, is in favor of Natural
Gas Storage Company of Illinois, a
Delaware Corporation, herein referred
to as Grantee.” These gas storage easements gave NGPL, as Grantee, “The
exclusive right, privilege and easement
to introduce natural gas or other gases
or vapors...into the (reservoirs)...to store
gas in said storage reservoir and retain
the possession of gas so stored as personal property, (and) to remove gas...
from the storage reservoir.”
The easements also gave NGPL the
right to drill wells, construct and maintain those wells, lay pipes and electrical
lines on the Grantees’ properties, and
to enter onto the Grantees’ properties to
maintain the wells and pipes.
In assessing and taxing the subject
76 acres which housed the compressor
station, the Kankakee County Board
of Review relied on Section 1-130 of
the Illinois Property Tax Code, which
states that taxable real estate includes
“all rights and privileges belonging or
pertaining thereto.” 35 ILCS 200/1-130.
The assessing officials treated the offsite easements, government permits,
and rights to use the reservoirs for gas
storage as “rights and privileges belonging or pertaining to” the subject 76
acres.
If the county’s analysis was accepted, any easements granted by owners
of private property to allow a utility
company or other regulated entity to
run wires, cables or pipes over or under
that property, or to store gas under the
surface land, could be assessed and
taxed as a “right or privilege belonging
or pertaining” to the land on which the
utility company’s corporate headquarters or central switching station was situated or, arguably, any property owned
by that entity within the county.
It is important to note the distinction
between easements appurtenant versus
easements in gross. The Supreme Court
stated that an easement appurtenant is
“created to benefit another tract of land,
the use of easement being incident to
the ownership of that other tract.” Id.
at pg. 9, citing Black’s Law Dictionary,
549 (8th Ed. 2004). An easement
appurtenant runs with the land and creates a servient estate (the real estate of
the Grantor) and a dominant estate (the
real estate of the Grantee).
On the other hand, an easement in
gross is defined as “(a)n easement benefitting a particular person and not a
particular piece of land.” Id. Easements
in gross create a servient estate (the real
estate of the Grantor), but are granted
to a person or entity without referring
to a specific parcel of land owned by
the Grantee. So an easement in gross
is personal in nature and is not dependent upon the ownership of a dominant
estate. The court found that the wording
of the gas storage easements clearly
indicated that the easements were in
gross, and benefitted the taxpayer rather
than the subject property.
The court stated that the classification of the easement is relevant in
determining whether an easement
can add value to another property. For
example, if an easement is appurtenant,
naming a utility or gas company’s parcel of land as the beneficiary (i.e., dominant estate) of the right to place wells,
pipes, wires, etc. on the land of others,
then these rights could add value to
the utility or gas company’s property
and could be assessed and taxed as
such. However, where an easement is
in gross, benefitting the utility or gas
company and not specifically identified corporate-owned land, then these
rights would not add real estate value
to the utility or gas company’s property
and could not be assessed and taxed as
such. Rather, an easement in gross, like
a gas storage or utility easement, would
contribute to the value of the business
of the gas storage or utility company,
and cannot be taxed as real property.
The county also argued that certain governmental regulations and
ordinances granting NGPL the right to
operate a gas storage field served as
evidence that the rights and privileges
to the gas storage reservoirs accrued to
the taxpayer as “rights and privileges
belonging or pertaining to the subject
property.” However, the Supreme Court
found that Illinois case law is consistent
in holding that government permits,
ordinances, licenses, orders, or regulatory approvals do not create assessable
entities. Id. at pg. 10.
The court relied on Central Illinois
Public Service Co. v. Swartz, 284 Ill.
108 (1918). In Swartz, the Plaintiff was
granted, by ordinance, the right to construct and maintain an electric plant
as well as electric poles and wires in
the town of Bushnell. The Swartz court
rejected the assessment and taxation of
the franchise as tangible property. The
court found:
This permission or license
exists independently of the poles,
wire, apparatus, machinery or
other means whereby it may be
available. It attaches not to the
tangible property of the corporation but to the franchise, and
would remain and be available to
the corporation if all its tangible
property were destroyed.
Swartz, 284 Ill. at 112.
In the instant case, the court found
that all of the governmental orders
attach to the taxpayer and not to the
subject property. The court found that
just as in Swartz, should NGPL choose
to leave the subject property, or suffer
any destruction of its tangible property, the orders would remain in place,
continuing to benefit taxpayer regardless of where its property was located.
Kankakee County Board of Review v.
Property Tax Appeal Board et al., No.
102318, 2007 WL 1650564, at pg.
10 (Ill. June 7, 2007). The court found
that the rights to store gas in the underground reservoirs accrue to taxpayer,
and do not pertain to NGPL’s 76 acres.
The rights and privileges that NGPL
enjoys to the underground storage
areas neither belong nor pertain to the
subject property for purposes of Section
1-130 of the Illinois Property Tax Code.
Id.
In order to determine whether an
easement is in gross or appurtenant,
one must look to the plain language of
the easement. If the easement is benefitting a particular person or company
and not a specific piece of land, then it
Vol. 53, No. 8, February 2008
Real Property
is an easement in gross. Since gas storage and other utility easements benefit
the gas storage company and utility
company rather than its land, these
easements are typically easements in
gross. As such, any added value would
enhance the business value of the gas
storage or utility company and not
its headquarters or switching station.
Also, any government permits, ordinances, licenses, orders, or regulatory
approvals are also personal in nature
and would enhance the business value
of the utility company and not its real
estate.
Easements granted by owners of private property to allow gas storage and
utility companies to run pipes, wires or
cables over or under that property cannot be assessed and taxed as benefitting unrelated property of the grantee.
The land on which these gas storage
or utility easements sit is already being
assessed and taxed to the owners of
the servient estate. Any enhancement
or diminution of value resulting from
such easements should be reflected
in the assessments of the encumbered
parcels.
__________
*Francis W. O’Malley is a Partner with
Worsek & Vihon LLP, concentrating in property tax appeals.
Life Estate Transaction legal considerations
By Alan E. Stumpf, Columbia, Illinois*
F
requently a lawyer is contacted
by a client proposing various
types of life estate and gift
transactions for real estate. To serve
our clients better we need to be thinking and counseling about a number of
future responsibility, transaction and
taxation issues.
Use of a life estate can present many
legal problems. Most legal advice
for real estate transactions will point
toward the use of trusts. See R. Hunter,
“Estate Planning and Administration
in Illinois,” §39.1 et. seq., (3rd ed.
1999), for a discussion of general
considerations related to a life estate
transaction. Illinois has not yet enacted
a statute providing for a transfer on
death real estate transaction; therefore
there is no analysis of transfer on death
transactions. For more information see,
S. Gary, “Transfer-on-Death Deeds: The
Nonprobate Revolution Continues,” 41
Real. Prop. Prob. & Tr. Jrnl. 529 (Fall,
2006).
Notwithstanding our recommendations, our clients insist on using the
life estate. What seems to be a simple
real estate transaction will require us
to think about what can happen after
the deed creating the life estate and
remainder interest has been signed and
recorded.
The following are a variety of rules
to be considered when planning a
transaction involving a life estate. Every
time you check the rules on Medicaid
in Illinois expect changes, since the
Vol. 53, No. 8, February 2008
Debt Reduction Act of 2005 provisions found in 42 U.S.C. 1396p have
not yet been adopted in the Illinois
Administrative Code as of November,
2007. See 95 Ill. Bar Journal 586 (Nov.
2007).
References to “Code” or “I.R.C.”
shall refer to the Internal Revenue
Code of 1986, 26 U.S.C. section 1 et
seq. References to prior versions of the
Code will indicate the year the version
became effective. Also, references to
“section” without further modification shall refer to sections of the Code.
References to “Treasury Regulation”
or “Treas. Reg.” refer to the Treasury
Regulations, Title 25 of the Code of
Federal Regulations. For I.R.C. and
regulations see:
Title 26 statute provisions see:
<http://uscode.house.gov/search/
criteria.shtml>.
Treasury Regulations see: <http://
www.access.gpo.gov/cgi-bin/
cfrassemble.cgi’title=200126>.
Note: IRS regulations require us to tell
you that, unless otherwise specifically
noted, any federal tax advice in this communication was not intended or written
to be used, and it cannot be used, by any
taxpayer for the purpose of avoiding penalties; furthermore, this communication
was not intended or written to support
the promotion or marketing of any of the
transactions or matters it addresses.
The problem: Elmer, age 75, and
his sister, Alma, age 65, have been living on the forty acre family homestead
since their mother died 20 years ago.
Elmer has a medical diagnosis that
could trigger nursing care, but that
medical event has not yet occurred.
Elmer wants to leave his assets to his
sister for the balance of her life, and
then, when she dies, in equal shares to
the National Rifle Association and his
local church endowment fund, and specific gifts of $5,000 each to his niece
and nephew.
He wants to live in his home as
long as his sister can care for him. The
five acre curtilage of the residence
and farm outbuildings is appraised at
$225,000 and the remainder of the
acreage is now worth $6,000 per acre.
The income tax basis on this inherited
property is $160,000 less depreciation
on the farm buildings. Elmer and Alma
have been splitting everything equally
and each now owns about $150,000
in cash or investments that could be
used to pay nursing care bills. Alma has
no diagnosed illnesses. Elmer wants to
give his undivided one-half interest to
his sister, but reserve a life estate, and
give his cash outright to his sister on
his death. If Alma dies before Elmer,
she wants to give her assets to Elmer in
trust for his “use and benefit,” with the
remainder to Eureka College, Eureka,
Illinois (in memory of Ronald Reagan),
and a church grade school scholarship fund, and $50,000 each to her
niece and nephew. She wants money
Real Property
left after Elmer dies, but wants to help
Elmer, particularly if he is hospitalized
or requires nursing care. What are you
going to tell Elmer and Alma about their
estate plan risks?
1. Life Tenant and Remainderman
Real Estate Common Law Rules. The
life tenant can use the property as he
sees fit, provided that no damage is
done to the remainder interest. Chicago
& A.R. Co. v. Goodwin, 111 Ill. 273
(1884).
A life tenant owes the remainderman
the duty to prevent waste to the property. Sexton v. Marine Bank of Springfield,
247 Ill.App.3d 763, 617 N.E.2d 869,
187 Ill.Dec. 412 (4th Dist. 1993).
Waste occurs when the life tenant
destroys, misuses, alters, or neglects
the property, thereby prejudicing the
remainderman’s right to possession
or diminishing the value of the land.
Hausmann v. Hausmann, 231 Ill.
App.3d 361, 596 N.E.2d 216, 172 Ill.
Dec. 937 (5th Dist. 1992).
A life tenant must make ordinary
repairs but not extraordinary ones. In
Honeyman v. Heins, 131 Ill.App.2d
981, 268 N.E.2d 907 (4th Dist. 1971),
fire destroyed the home. The remainderman wanted the insurance money
collected by the life tenant. The remainderman claimed that the life tenant
failed to make ordinary repairs by not
rebuilding the home to its original condition. The court ruled that the scope of
ordinary repairs did not include replacing the building.
The life tenant can cultivate and
harvest crops planted prior to the termination of the life estate. Keays v. Blinn,
234 Ill. 121, 84 N.E. 628 (1908).
The life tenant may have the right
to cut, sell, or remove timber if the
land is not damaged or diminished in
value. McDole v. McDole, 39 Ill.App.
274 (1890); Stewart v. Wood, 48 Ill.
App. 378 (1892); and Chapman v. W.F.
Epperson Circled Heading Co., 101 Ill.
App.161 (1901).
The life tenant must maintain the
buildings, fences, and other improvements on the land. Thelin v. Hupe, 397
Ill. 44, 72 N.E.2d 735 (1947).
The life tenant must pay taxes and
assessments. Coppens v. Coppens, 395
Ill. 326, 70 N.E.2d 54 (1947).
A life tenant has no duty to make
permanent improvements to the land.
Therefore, he cannot claim reimbursement from the remainderman if he
does. Leininger v. Reichle, 317 Ill. 625,
148 N.E. 384 (1925).
Richard Bales’ comment on damages: “It is not only a question of what
duties the life tenant has, but what remedies are available to the remainderman
should the life tenant breach any of
those duties. Possibilities include actual
damages, punitive damages, injunction,
and forfeiture of the life estate and treble damages as provided by the Statute
of Gloucester. Surely, you remember
the Statute of Gloucester passed by
Parliament in 1278 and arguably made
applicable in Illinois pursuant to 5 ILCS
50/1. At least that was the argument
that was made in Wise v. Potomac Nat’l
Bank, 393 Ill. 357, 366 (1946). What?
You don’t buy that argument? Well, neither did the court; but actual and punitive damages and injunctive relief are
available remedies.”
Note: A special thanks to ISBA Listserve
comments of Richard Bales and others
for the above commentary.
2. Capital Gain Tax and Internal
Revenue Code §1014 Basis Rules.
Generally, the basis of any property
acquired from a decedent is the fair
market value on the date of decedent’s
death. I.R.C. §1014 However, property
that is gifted retains the donor’s basis.
I.R.C. §1015. The conclusion to be
drawn is that appreciated property will
escape capital gains taxation on the
date of death. Step up basis may be limited in the future by the repeal of I.R.C.
§1014 if death occurs in 2010. I.R.C.
§1022. The step up basis of a decedent
is limited to $1,300,000 in 2010. At a
surviving spouse’s death, the step up
basis is limited to $3,000,000 in 2010.
I.R.C. §1022. We need to think about
carry over basis as tax policy in the
future, notwithstanding the “experts’”
predictions.
Question: What if the life estate is
inherited and the remainder is inherited under a decedent’s will? Is there
another step-up on the death of the life
tenant?
3. Internal Revenue Code 121
Residential Gain Exemption Rules. If a
single person sells his or her residence
that has appreciated in value, the gain
on sale of residence is excluded up
to the amount $250,000. If married
persons sell their residence that has a
appreciated in value, the gain on sale of
residence is excluded up to the amount
$500,000. I.R.C. §121. The tax conclusion for a gift is to sell the home, avoid
taxation of the gain and use or distribute the money income tax free. Gift
taxes may be incurred if gifts are made
in excess of $12,000 (annual exclusion
amount) in 2007. I.R.C. §2503(b). Rev.
Proc. 2006-53.
Income Taxes If Elmer and Alma Sell the
Residence: Applications of Code §§1014
and 121.
After conveying his one-half (1/2)
remainder interest to Alma in 2007,
Alma and Elmer decided to move to
Florida and sold each of their interests
in the residence on January 31, 2008,
for One Hundred Ninety Thousand
Dollars ($190,000). Elmer’s adjusted
basis on the residence was Sixty
Thousand Dollars ($60,000) resulting in
a gain of Thirty-Five Thousand Dollars
($35,000). What is the gain that is not
taxable under Code §121?
Answer: (Remember that Elmer and
Alma have lived in the house since
they inherited it). When the remainder
interest is transferred while retaining
the right to live there until death, a life
estate (Elmer’s ½ portion) and a remainder interest (Alma’s ½ portion of Elmer’s
interest) are the result. If the residence
were not sold until after Elmer would
die, Alma would have received a onehalf (1/2) stepped-up basis. If Alma sells
the house soon after Elmer dies, the
sale will (assuming sales price equals
date of death value) not result in a
taxable gain as to Elmer’s undivided
one-half (½) interest. If Elmer and Alma
sold Elmer’s one-half (½) interest while
Elmer is still living, they each receive a
portion of the gain.
Since Elmer and Alma meet the two
out of five year ownership and occupancy test, Elmer can claim the sale of
residence exclusion on his life estate
portion that may apply to the residence.
Alma’s undivided one-half (1/2) fee
interest will be excluded from gain
under Code §121. However, the gain
on the one-half (1/2) remainder interest
portion will be taxable to Alma even
though she also lived in the house.
The life estate portion is calculated
by applying the §7520 rate (120% of
the Applicable Federal Midterm Rate)
for the month the residence is sold to
Table S of IRS Publication 1457, using
Elmer’s age closest to the date of sale,
to find the factors that represent the life
estate and the remainder interest.
For January 2008 the §7520 rate is
4.4%. The next step is to go to Table S
Vol. 53, No. 8, February 2008
Real Property
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some pretty good lawyers.
We’re out to keep it that way.
Real Property
(4.4%) (Publication 1457, page 12) for
the needed factors. Elmer’s life estate
factor (for age 76, since he will be 76
years of age in 2008) is 0.33840, while
Alma’s remainder factor is 0.66160.
Elmer’s gain is determined by multiplying 0.33840 by the $35,000 gain to
establish the part of the sale he can
exclude under §121. Alma will report
as taxable the remaining 0.66160 of the
$35,000 gain for the remainder interest
of the residence. She did not own the ½
remainder interest as a resident two out
of the past five years.
Note: Table S is contained in IRS Pub.
1457, Actuarial Values-Book Aleph.
Since Pub. 1457 is 880-pages long, the
NATP Research Department can assist
in locating the factors. See also Treas.
Reg. §20.2031-7, 26 CFR Ch. I (4-1-01
Edition).
4. Gift and Estate Tax Rules. The lifetime transfer of a remainder interest is a
taxable gift under I.R.C. 2511, and the
partial interest of the remainder is valued under. I.R.C. §2512. See Treas. Reg.
§25.2512 (d)(2)(ii). However, a gift of a
remainder interest is not eligible for the
annual exclusion, since it is not a gift of
a present interest. I.R.C §2503(b).
Notwithstanding basis rules concerning the income tax basis of ordinary gifts under I.R.C. §1015, under
I.R.C. §1014(a) the step up basis on
date of death rule applies to remainder interest property (subject to I.R.C.
§1016(a)(2)(B) adjustments for prior
deductions) because interests retained
by a decedent are required to be
included in the decedent’s gross estate
for federal estate tax purposes (such
as the full value of property passing as
a life estate under I.R.C. §2036 even
though the partial remainder interest was subject to lifetime transfer gift
taxation unless the transferee sold or
otherwise or disposed the remainder
interest property before the decedent
died. I.R.C. § 2036). There is a potential
for both gift taxation and estate taxation
if the values are high enough. Gifting of
the remainder interest may be of economic use only in smaller estates.
5. Medicaid Rules under 42 U.S.C.
1396p and Illinois Administrative
Rules.
The Debt Reduction Act of 2005
mandates denial of Medicaid benefits if a gift is made within 5 years
of the date of application. 42 U.S.C.
1396p. Currently the Illinois requirements for Medicaid benefits is thirtysix (36) months (from the date of the
gift transaction). 89 Ill.Adm. Code
120.387(e)(1)(B). This rule is expected
to change soon!
Gifts of a remainder interest while
retaining a life estate will create an
ineligibility period based on the present value of the remainder interest of
the gifted property. The values of the
life estate and remainder interest are
determined as described in 89 Ill.Adm.
Code 120.380 and 89 Ill.Adm. Code
113.140. 89 Ill.Adm. Code 120 TBL.
A provides a table of the factors for a
life estate and a remainder interest.
These tables are not identical to Table S
actuary values found in IRS Publication
1457. See also Treas. Reg. 20.2031-7,
26 CFR Ch. I (4-1-01 Edition).
Calculation of ineligibility. Semi-private and private nursing care rooms in
Monroe County, Illinois, have costs that
are between $3,000 and $6,000 per
month based on a July 2007 survey. The
monthly rate used by the local public
aid office will be the private rate at the
nursing care facility that is selected by
the public aid applicant. Again, this
rule may change.
If the gifted remainder interest is in
a homestead, the gift of the remainder
interest is an allowable transfer if the
remainder interest in homestead property was transferred to:
a. a spouse;
b. a person’s child who is under age
21;
c. a person’s child who is blind or disabled;
d. a sibling who has an equity interest
in the homestead property; or
e. the person’s child who provided
care for the person and resided in
the homestead property for two
years immediately prior to the
date the transferor became institutionalized. 89 Ill.Adm. Code
120.387(e)(3).
If a person who applies for Medicaid
retains a life estate the life estate will
be exempt if the person lives in the
life estate at least one year. Also, if a
remainder interest in a homestead is
conveyed to a person’s sibling who has
equity interest in the homestead and
the sibling is living in the homestead for
at least one year before facility admission or benefit application, the transfer
of that remainder interest in a homestead to the sibling will be an exempt
transfer not creating a period of ineligibility for purposes of Medicaid. 89 Ill.
Adm. Code 120.387.
If the value of the life estate for the
homestead is in excess of $500,000,
there may be disqualification for owning a substantial home equity under the
Debt Recovery Act of 2005. No comparable Illinois Administrative Code provision existed on November 1, 2007. 95
Ill. Bar Journal 586 (Nov. 2007).
Caution: It is not presently clear whether
the Illinois Administrative Code and
applicable agency rules have been
changed to adopt the provisions of the
Deficit Reduction Act of 2005. In planning the transaction, the public aid office
should be consulted for the most recent
rules and regulations of the Illinois
Department of Healthcare and Family
Services and the Illinois Department of
Human Services.
6. Real Estate Tax Assessment Rules.
If a life estate is reserved the following real estate assessment exemptions
should be preserved:
a. Homestead Exemption of $5,000
b. Senior Exemption of $3,000
c. Senior Valuation freeze (amount
will vary dependent on the facts).
If the residence is placed in joint
tenancy with one or more children,
there is no Department of Revenue
guideline addressing whether the
homestead exemption, senior exemption and senior valuation freeze would
be preserved. This remains a judgment
call for the local assessor who may
assume residence if the donor-senior
is residing on the property and the tax
bill is mailed to the senior citizen at the
jointly-owned residence.
If the donor-senior requires nursing care and maintains the use of the
residence to the exclusion of others and
the tax bill is mailed, this is a judgment
call for the assessor and the exemptions and freezes to assessment may be
preserved.
However, if the property is deeded
outright to a child or children the
homestead exemption, senior exemption and senior evaluation freeze would
definitely be lost.
7. Creditor Rules. Illinois homestead
exemption rules would apply to a life
estate but may not apply to a remainder
interest. Even if the client has no creditors, a child or a sibling of that client
may have creditors that can attach real
Vol. 53, No. 8, February 2008
Real Property
estate if it is conveyed to that child or
sibling. Further, if the client has debt,
the transfer of a remainder interest or a
gift may be a fraudulent transfer under
the Illinois statutes.
8. Personal Factors. Financial and
personal integrity of a child or sibling
needs to be weighed carefully.
9. Medicaid and “family trust” rules.
Gifting of the remainder and reserving
the life estate of a residence will require
a careful investigation of other assets
when determining Medicaid eligibility
for your clients.
Federal estate tax laws have allowed
various amounts to be excluded from
estate taxation. For example, this
amount has been referred to since 1976
as “credit shelter,” “unified credit,”
or “applicable exclusion” amounts.
Trusts to hold these amounts have been
labeled “Trust B,” “Family Trust,” “Credit
Shelter Trust,” “Unified Credit Trust,”
“Applicable Exclusion Trust,” or other
trusts. A common trust label is “Family
Trust” and that term will be used for
purposes of this memorandum.
A senior citizen (while retaining a
life estate and conveying a remainder
interest to another) may be benefited
by a family trust. Careful examination
of the family trust needs to be made to
determine if the family trust includes
provisions allowing it to be discretionary only, or income only with invasion
of principal solely discretionary by a
non-spouse trustee. Family trust provisions may have the benefit of being partially or totally exempt from Medicaid.
This will be determined by standards
of distribution in the trust document.
Provisions concerning special needs of
a beneficiary may require additional
drafting to protect attachment of assets
by a governmental agency. See BNA
Estates, Gifts and Trusts Journal, July
12, 2007, Sebastian Grassi, “Estate
Planning for Families with a Special
Needs Child”
10. Ethics in Life Estate Transactions.
A. Conflict of Interest. In parent
and child transactions, have you documented that the child is not represented
and may need advice of counsel? One
of the persons in a “joint representation” may be unhappy with the family
trust idea, especially if both persons are
healthy and one of the persons does not
own equal assets. Be careful to discuss
and disclose your ethical duties when
counseling about any estate planning
matter. Medicaid planning for spouses
may require two attorneys, just as representation in pre-marital agreements.
B. Unauthorized Practice of Law. Is
this transaction precipitated by a securities salesperson or financial planner?
Has an undisclosed annuity been purchased or an undisclosed transfer been
made by your client? Has your client
only told you part of the financial facts?
What do you tell your client about
unauthorized practice of law (UPL)?
What is your duty to investigate unauthorized law practice? Can the client
waive this investigation?
C. Engagement and Waiver
Considerations. Most clients want you
to draft the life estate/remainder deed
and nothing more. How many clients
phone inquiries start, “How much will
it cost to do a life estate transaction”?
Has your client only told you part of
the financial facts? What is your duty to
investigate Medicaid and UPL transaction facts (and bill your client for it)?
Can the client waive this investigation?
How is the scope of representation
documented when problems are discovered midway in representation or at
the signing conference? Do you have a
special retainer agreement for life estate
transactions?
D. Fraudulent Transfer and Grantor’s
credit status. In counseling our life
estate transaction clients we need to
ask questions concerning our clients’
balance sheets and understand the
collection status of debts and the legal
rules that apply to those facts before
establishing a life estate transfer. Under
the Fraudulent Transfer Act, a creditor
may avoid a transfer if the debtor made
the transfer with the actual intent to
hinder, delay, or defraud any creditor of
the debtor. The Fraudulent Transfer Act
(740 ILCS 160/5(b)) lists eleven factors
that may be considered in determining
the debtor’s actual intent in making the
transfer. If enough of these factors are
present, the requisite actual intent may
be found, and the property, including
the remainderman’s interest may be
subject to a creditor’s rights.
E. IRS Circular 230. What do we
write to our clients to comply with
Internal Revenue Service Circular 230?
__________
*Alan E. Stumpf practices in Columbia,
Illinois, where his general practice includes
real estate, wills, trusts, estates, business
transactions, taxation, family, municipal and
criminal law. He is a trained mediator/reconciler for the Lutheran Church-Missouri
Synod.
2007 Amendments to ILCS 770 60/23 – The Public
Lien Act – Public Act 095-0274
By Julius Shapiro*
H
oward Turner in his article in
the December 2005 Illinois
Bar Journal discussed the
amendments to the Private Sector of the
Mechanic Lien Act, which amendments
became effective January 1, 2006.
Lacking from the January 2006
Vol. 53, No. 8, February 2008
amendments was any amendment to the
section of the Mechanic Lien Act that
deals with public works. That section is
found in 770 ILCS 60/23. The reason for
the lack of amendments to the January
1, 2006, law was due to a time problem, and the committee that proposed
the 2006 amendments determined that
the public lien changes, if any, would be
dealt with at another time.
In 2006 and in 2007 the subcommittee formed by the Construction
and the Mechanics Lien Committee
of the Chicago Bar Association again
Real Property
convened to draft amendments to the
Public Lien section of the Mechanic
Lien Act. This subcommittee consisted
of a number of attorneys who previously worked on the January 2006
amendments with additional attorneys
who practiced in the public sector. These attorneys worked with the
Municipal Committee of the Chicago
Bar Association and together formulated proposed amendments.
From this committee proposed
amendments were approved by the
Chicago Bar Association, which then
sponsored the amendments as part
of Senate Bill number 330 that was
passed by both the Illinois Senate and
the House and enacted into law by the
Governor effective August 17, 2007.
The following is a brief summary
of the changes that became law. The
changes, except for the definition of
unit of local government as set forth
hereinafter, apply to both the state and
local governmental work.
1. The following definition is now
part of the public lien law.
For the purpose of this
Section, “unit of local government“ includes any unit of local
government as defined in the
Illinois Constitution of 1970,
and any entity, other than the
State, organized for the purpose
of conducting public business
pursuant to the Intergovernmental
Cooperation Act or the General
Not For Profit Corporation Act of
1986, or where a not-for-profit
corporation is owned, operated,
or controlled by one or more
units of local government for the
purpose of conducting public
business.1
2. The definition of items lienable
now includes “labor, services,
apparatus forms or form work,”
which items are similar to lienable
items for the private sector.2 3
3. All notices of any claim per the
act must be in writing and contain
a sworn statement identifying the
claimant’s contract, describe the
work done by the claimant, state
the total amount due and unpaid
as of the date of the notice for the
work, and include that date.4 These
requirements make the non-state
notices confirm to State notices.
4. The lien attaches only to the portion of the money, bonds, or warrants against which no voucher or
10
5.
6.
7.
8.
9.
other evidence of indebtedness has
been issued and delivered to the
contractor by the public body at
the time of the notice.5
A subsequent notice of a claim or
action for an amount or amounts
becoming due the lien claimant
on a date after the prior notice or
notices is not prohibited.
The notice of the claim asserting a
lien shall be effective when refused
or received by the proper party per
the statute.6
The time period for service of a
complaint for accounting, which is
the remedy asserted by a claimant,
on the appropriate public official is
now 10 days after the filing of the
complaint for accounting, and the
public official must hold such sums
that are needed to pay the claim for
the 90-day period plus the 10 days.7
In the event a suit to enforce a
claim, based on the notice of a
claim for lien, is commenced per
the requirements of the statute and
the suit is subsequently dismissed,
the lien for the work claimed under
the notice of the claim for lien shall
terminate 30 days after the effective date of the order dismissing the
suit unless the lien claimant shall
file a motion to reinstate the suit,
a motion to reconsider or a notice
of appeal either event within the
30-day period. Notwithstanding
the forgoing, the public body is
not precluded from paying a claim
within 30 days of the dismissal.
To make the public lien claims
consistent with the private lien law,
unless the contract of the general
contractor with the State, or local
governmental body otherwise provides, no lien for material shall be
defeated because of lack of proof
that the material, after delivery,
actually entered into the construction of the building or improvement, even if it is shown that the
material was not actually used in
the construction, so long as it is
shown that the material was delivered either (i) to the owner or its
agent to be used in that building
or improvement or (ii) pursuant to
the contract, at the place where the
building or improvement was being
constructed or some other designated place, for the purpose of
being employed in the process of
construction as a means for assisting the erection of the building or
improvement in what is commonly
termed forms or form work where
concrete, cement or like material is
used, in whole or in part.
The subcommittee hopes that the
changes described above will eliminate
inconsistencies and address unanswered questions that arose from a law
that originally was enacted in the early
1900s but was only changed in piecemeal over the long period thereafter.
Time will tell.
__________
*Mr. Shapiro is an attorney with Berger,
Newmark,& Fenchel P.C., in Chicago and
acted as chairman of the subcommittee of
the Chicago Bar Association that prepared
the changes to both the private and public
sector provisions of the Mechanics Lien Act
that were enacted into law.
1. 770 ILCS 60/23 (a-5)
2. 770 ILCS 60/23 (b)
3. 770 ILCS 60/23 (b) (6)
4. 770 ILCS 60/23 (c) (1)
5. 770 ILCS 60/23 (b) 5 and (c) 5
6. 770 ILCS 60/23 b(1) and c(1)
7. 770 ILCS 60/23 b(4) (6) and c(4) (6)
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Vol. 53, No. 8, February 2008
Real Property
Supreme Court settles dispute between appellate
districts
By Gary R. Gehlbach
A
s reported in my Editor’s note
in the February 2007 issue
(Vo. 52, No. 6), the issue
of whether a real estate tax proration
merges with the deed has depended
on the appellate district. In 2005, the
Third District ruled that merger applies,
in Chapman v. Anchor Lumber, 355
Ill.App. 3d 438. However, the Second
District in Holec v. Heartland Builders,
Inc., 234 Ill.App. 3d 253 (1992), and
the First District in Czarobski v. Lata
ruled otherwise. The Czarobski defendants, however, were granted leave to
appeal.
On January 25, 2008, the Illinois
Supreme Court issued its opinion in the
Czarobski case. The factual situation is
not unusual. Mr. And Mrs. Czarobski
entered into a purchase contract to buy
a residence in Orland Park. Accrued but
unpaid real estate taxes, according to
the contract, were to be prorated based
on 105% of the last ascertainable tax
bill, unless that bill was based on a partial assessment. At the time of the closing in June 2005, the last ascertainable
bill was the bill for the 2003 taxes, and
the buyers’ credit was based on that
amount. However, apparently unknown
to the parties, that bill was based on a
partial assessment. When the actual bill
for 2004 was issued, the buyers found
themselves short by almost $8,000 for
the 2004 and their share of the 2005
taxes. The sellers, however, refused the
buyers’ request for this amount, and litigation ensued.
The trial court, relying on Lenzi
v.Morkin, 103 Ill. 2d 290 (1984), granted the defendant-sellers’ motion to dismiss, finding that the doctrine of merger
applied and that the Illinois Supreme
Court had never ruled that mutual
mistake was a basis to avoid merger by
deed. Interestingly, the Third District in
the Chapman decision used the same
rationale. The First District Appellate
Court, however, as noted above, distinguished the Lenzi case and found the
reasoning in Holec to be compelling.
The issue before the Supreme Court
was whether mutual mistake of fact or
misrepresentation when the deed is
Vol. 53, No. 8, February 2008
delivered should be bases to avoid the
merger doctrine. Acknowledging that
the Supreme Court had not previously
ruled that either of these was a basis to
ignore merger with deed, as the Third
District found in Chapman, the court
nonetheless agreed with the Czarobski
appellate court that “neither has [this
court] prohibited such an exception.”
Ergo, the Supreme Court ruled, merger
does not apply.
The Supreme Court decision also
distinguished the Lenzi decision, finding
that the defendant in that case “did not
invoke the merger rule.”
Mr. And Mrs. Lata argued that the
fact that the 2003 tax bill was based
on a partial assessment was of public
record. Noted the Supreme Court,
however, the normal procedure in a
residential real estate transaction does
not involve checking the tax records to
the extent necessary to determine this.
Or at least the defendants provided no
proof that this is the standard.
In any event, this issue appears to
be settled for now. Query whether the
title companies will change their standard form that they require buyers and
sellers to sign at residential closings to
the effect that the real estate tax proration as disclosed on the Settlement
Statement is not only agreeable but a
final proration. Perhaps this should now
include “Except in the case of mutual
mistake of fact or misrepresentation,...”
11
Real Property
Illinois Real Estate
Lawyers Association
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Suite 400
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Vol. 53 No. 8
February 2008
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