Tuesday, May 2, 2017
The distribution of property in accordance with a decedent’s will or trust can be a straightforward matter, or it can prove to be a trying event for the family. But, what if, for example, a parent dies and specifies in a will or trust that a particular family member is to get a specific item of property and it doesn’t exist at the time of death? Perhaps the specifically devised property has already been gifted to the beneficiary in satisfaction of the specific devise. Or, maybe the specifically devised asset has been disposed of pre-death and the will or trust still contains the specific devise language.
When either of these events happens, the legal doctrine of ademption is invoked. The pre-death gift situation is called an ademption-by-satisfaction, and the pre-death disposal situation is called “ademption -by extinction.” Ademption has the possibility of occurring anytime there is language in a will or trust that devised specifically identified property. It can even occur as the result of a rather straightforward tax-deferred exchange transaction, and frustrate the intentions of a testator’s estate plan.
Ademption - the topic of today’s blogpost.
Ademption – What Is It?
Ademption is a legal rule that governs the disposition of a bequest of specific property that is no longer in the decedent’s estate at the time of the decedent’s death. In general, for devises of specific items of property, called specific gifts, the property is adeemed, and the gift fails. For example, if a parent leaves a specific tractor to an identified beneficiary, but the parent didn’t own the tractor at the time of death, then the gift is said to have been adeemed and the beneficiary would either receive no gift at all or a portion of the gift. This is the likely result with specific bequests of tangible personal property and real estate.
Some gifts, however, are never adeemed. An example would be a gift of cash. If there is not enough cash in the testator’s estate to satisfy the gift, then other assets in the residuary estate are sold to raise the necessary cash. Some gifts are in a gray area, where the testator’s specific intent must be determined. Also, ademption may be waived if the property leaves the estate after the testator has been declared incompetent and a guardian has been appointed, or an agent acting under a power of attorney disposes of the property. See, e.g., In re Estate of Anton,731 N.W.2d 19 (Iowa 2007). Generally stock splits and stock mutations in the context of a business reorganization don’t trigger the doctrine – that’s just an exchange of specifically devised shares of stock for new stock, or the creation of more shares. However, the specific language in the dispositive instrument at death is key.
For real estate sales, the doctrine can apply even if the property hasn’t sold before the testator dies, but a contract for sale has been entered into before death. For instance, assume that a testator executes a will (or trust) that devises a property (for instance, a specific home) to an individual. Before death, the testator enters into a contract to sell the home to a buyer, but then dies before the closing. The devise of the home may be adeemed and the buyer will be entitled to specific performance of the contract. The rationale would likely be that once the contract is executed, equitable conversion occurred – the testator owned a contract right to the proceeds of sale and not the home. This result can be avoided if the will or trust says that the proceeds of sale follow the specifically devised property.
While an exchange of stock in a company as a result of a reorganization is not an ademption, what about an I.R.C. §1031 exchange of real estate. That’s a rather common transaction in agriculture. Does that trigger ademption when a specifically devised tract is traded for another tract? Indeed, it can if the tract is specifically identified and is not in the decedent’s estate at death.
In In re Steinberg Family Living Trust, No. 16-0380, 2017 Iowa Sup. LEXIS 44 (Iowa Sup. Ct. Apr. 28, 2017), a married couple created a trust and named themselves and one of their sons as co-trustees. Upon the last of the parents to die, the two sons were to be the co-trustees. Dad died in 2011 and the Mom died in 2013. The trust became irrevocable upon the Mom’s death and the sons became co-trustees. The trust provided that one son was to receive a specific 40-acre Iowa tract, and the other son would receive a specific 80-acre Iowa tract and have the first right to buy or rent the other 40-acre Iowa tract. Both tracts were identified by their legal description. The balance of the trust assets was to be split equally between the sons.
Sounds like a fine estate plan. The idea is to give each son a specific tract so they don’t have to deal with co-ownership issues after the last of the parents to die (and the seemingly inevitable forced-sale scenario), and give one son the first right to buy or rent the other son’s tract. But, here’s the rub – in 2008, the trust did a tax-deferred exchange of the 80-acre Iowa tract for the 80-acre Minnesota property. Thus, when the trust became irrevocable upon Mom’s death, the trust held the 80-acre Minnesota tract and the 40-acre Iowa tract (and other non-real estate assets). The son with the purchase option gave notice to buy the Iowa tract, and the other son then filed a declaratory judgment action claiming that the option only gave his brother the right to rent the property from him while he continued to own it. He also claimed that the Minnesota tract should be split between the two brothers, because the specific bequest of the 80-acre Iowa tract to his brother had been adeemed by the like-kind exchange. Of course, the other son claimed that the 80-acre Minnesota tract should be devised to him directly because it merely replaced the Iowa tract in a tax-deferred exchange transaction.
The trial court held that the gift of the 80-acre Iowa tract had been adeemed and, consequently, it was subject to the trust provision requiring it to be owned equally by the two sons. The trial court also held that the option only gave the one brother the first right to rent the Iowa tract from his brother for the price specified in the trust for as long as the other brother owned it.
On further review, the Iowa Supreme Court affirmed on the ademption issue, not recognizing any exception from ademption under Iowa law for property received in a like-kind exchange. The court refused to adopt §2-606(a)(5) of the Uniform Partnership Act which states, “a specific devisee has a right to specifically devised property in the testator’s estate at the testator’s death and to any real property or tangible personal property owned by the testator at death which the testator acquired as a replacement for specifically devised real property or tangible personal property.” The court opined that it was up to the legislature to specifically adopt the UPC provision, as it has done with other selected UPC provisions. Thus, the court affirmed the trial court’s decision and the brothers ended up owning the replacement property equally.
While the Iowa Supreme Court stated that its rule of interpretation for trusts was that “the testator’s intent is paramount,” that’s a stretch as applied in this instance. The result the court reached on the ademption issue most likely violated the precept by resulting in a co-owned tract of farmland which the trust provisions appear to have been trying to avoid. The court vacated the trial court’s ruling on the option provision and remanded the issue for consideration of extrinsic evidence as to its meaning.
Lessons? What looks to be purely a tax transaction can have extraneous implications in the law. Chances are that a non-lawyer tax practitioner has never heard of “ademption.” The client may want to do a like-kind exchange, for example, but if a tract is specifically identified in an estate plan and then it is exchanged, that can throw off the entire plan. While, it’s not the tax practitioner’s responsibility to worry about non-tax matters, perhaps knowing that the possibility of ademption exists can result in a question being asked to make sure the client checks with their attorney about the impact of the exchange on an existing estate plan. In the Iowa case, the exchange occurred about five years before Mom died. There was plenty of time to modify the trust language to avoid the impact of ademption. But, that doesn’t mean that strictly applying the rule of ademption was consistent with the decedent’s intent. It’s probably more likely that they never even thought of such a thing as ademption and its impact on the estate plan.
So, whenever a specific gift of real property is provided for by testamentary instrument, the testator should be made aware of the possibility of ademption. But, check state law. Some states have “anti-ademption” statutes or use the UPC rule mentioned above.