Part II: An In-Depth Analysis of U.S. Tax Implications for Usufruct Arrangements

Estate planning in many civil law jurisdictions often involves splitting full property ownership into two distinct parts: the right to use and enjoy the property (the usufruct) and the underlying legal title (the bare ownership). Although this method serves both tax and non‐tax objectives abroad, it poses unique challenges under U.S. tax law, where there is no direct counterpart to these civil law concepts. U.S. tax authorities therefore frequently draw analogies—comparing the arrangement to gifts of future interests, testamentary bequests, foreign trusts, or even joint tenancies—to determine its tax treatment.

Basic Framework of Usufruct and Bare Ownership

When an individual retains a usufruct, they secure the right to benefit from an asset during a specified period (often their lifetime) while another party receives the bare title. For instance, in real estate, the usufructuary may live in the property or collect rental income, whereas the bare owner holds title without immediate use. Similarly, with financial assets like stocks, the usufruct holder receives dividends and income, while the bare owner’s rights to capital appreciation remain on hold until the usufruct ends.

For U.S. taxpayers, the income generated by the usufruct—such as rents or dividends—is taxable. In contrast, the bare owner generally does not face current income tax on the asset’s earnings until a triggering event (like a sale) occurs. However, future capital gains are calculated using the donor’s original basis, potentially increasing tax liability if the asset has appreciated significantly.

French Tax Planning and Divided Ownership

French estate planning has long employed divided ownership strategies because of steep gift and inheritance taxes—rates can climb as high as 45–60% between close relatives, with a modest annual exemption. In this system, when a donor transfers the bare ownership while retaining usufruct, the bare interest is valued at a fraction of the full property’s worth. For example, depending on the usufructuary’s age, the bare interest might be appraised at as little as 90% of the property's value.

This valuation method is coupled with a favorable “step-up” in basis: when the gift is made, the bare ownership is revalued to its fair market value, erasing any built-in gain for future sales. Additionally, because French law renews a modest exemption every 15 years, long-term planning can further reduce estate tax exposure. The net effect is that retaining a usufruct while transferring bare ownership becomes an attractive strategy for inter vivos transfers and estate planning under French tax rules.

The French Model of Divided Ownership

Under French law, full property rights are divided into:

Usufruct: Grants the right to use the asset and collect income (such as rent or dividends). The usufructuary is responsible for maintaining the property’s condition during the term.

Bare Ownership: Represents the legal title without the right to immediate enjoyment. The bare owner can eventually sell or transfer the property but is restricted during the usufruct term.

Transfers of bare ownership must be executed through a notarial deed and are subject to legal restrictions. For example, if the bare owner is also an heir under forced heirship rules, the transfer might be considered an advance on inheritance. Further, conditions in the deed may prevent the bare owner from selling or encumbering the property without satisfying specific criteria, ensuring the donor’s retained rights remain protected.

U.S. Tax Treatment: Life Estates versus Trust Structures

U.S. tax authorities have addressed the tax consequences of usufruct and bare ownership arrangements in several rulings, though their guidance is not entirely consistent. Broadly, the analysis tends to fall into two frameworks: treating the arrangement as a life estate or as a trust.

Treating the Arrangement as a Life Estate

In Revenue Ruling 64‑249, the IRS examined a case involving a Louisiana usufruct in S corporation shares. The court analogized the arrangement to a life estate—where the usufructuary is entitled to the economic benefits (like dividends) for life, while the remainder (bare ownership) passes to other beneficiaries. The IRS concluded that the usufruct holder should include the S corporation’s dividend income in gross income and be treated, for certain tax purposes, as if they were the owner.

A similar approach was taken in another ruling (LTR 201032021) involving a foreign holding company. Here, even though the donor transferred the legal title to her descendants, she retained full economic benefits through her usufruct. The IRS thus regarded her retained interest as equivalent to a life estate, emphasizing that she maintained the power to enjoy income from the shares throughout her lifetime.

Analyzing the Arrangement as a Trust

Other rulings have focused on whether the arrangement should be viewed as establishing a trust. In LTR 9121035, for example, a foreign individual received a usufruct interest through his mother’s will while the bare ownership passed to his children who were dual citizens of the U.S. and the foreign country. The IRS ruled that, because the usufruct retained all the income benefits and the arrangement met specific trust characteristics under entity classification rules (the father was usufruct holder, the executor, and had the responsibility to protect and conserve the estate for his children), it should be treated as a trust for U.S. federal tax purposes.

Similarly, in LTR 8748043 the IRS grappled with the issue of which party should be considered the owner of a foreign corporation’s stock for purposes of controlled foreign corporation rules. Since the usufruct holder received 100% of the income from the stock during the usufruct term, the IRS cited to Treas. Reg. Section 1.958-1(c)(2) and determined that, for anti-deferral purposes, the usufructuary was treated as the owner—thus shielding the bare owners from immediate tax liabilities on certain distributions.  This decision was consistent with the IRS’s position taken in Rev. Rul. 64-249 discussed above.

Special Cases: Incomplete Gifts and Testamentary Dispositions

Not every arrangement neatly fits into a completed gift framework. In LTR 201825003, a transfer of valuable artworks was structured so that the donor and spouse retained a usufruct while the remainder interest was designated for foreign museums. Although conditions existed that might have allowed revocation of the transfer, the IRS ultimately concluded that the gift was complete for U.S. gift tax purposes—meaning the full value of the artwork would eventually be included in the donor’s estate.

In Estate of Lepoutre v. Commissioner, 62 T.C. 84, a French marital contract that created a usufruct on community property was considered, for U.S. estate tax purposes, as a testamentary disposition. Even though the surviving spouse’s rights arose during the donor’s lifetime, they only fully materialized upon death, and thus the transfer was taxed accordingly.

Income Tax Considerations for Usufruct Holders

From an income tax perspective, a U.S. taxpayer holding a usufruct is generally taxed on the full income generated by the asset—whether that income comes in the form of rent, dividends, or other returns. This treatment mirrors that of an outright owner. To avoid double taxation, any income taxed in a foreign jurisdiction may be eligible for a foreign tax credit.

Nonetheless, complexities emerge when U.S. taxpayers hold usufruct interests in foreign entities. For example, anti-deferral regimes such as subpart F can apply if the economic benefits derived from a foreign corporation’s shares are attributed solely to the usufruct holder. Determining the precise allocation of income between the usufruct holder and the bare owner requires a detailed review of both U.S. tax principles and the applicable foreign law.

Conclusion and Key Considerations

Despite the limited and occasionally inconsistent guidance from U.S. authorities, several themes emerge when analyzing the tax treatment of usufruct and bare ownership arrangements:

Document Review: A careful examination of the legal documents that establish the property split is essential. Understanding the precise rights and restrictions under both U.S. and foreign law is critical.

Variety of Fact Patterns: The specifics of each arrangement—ranging from the degree of control retained by the usufruct holder to how economic benefits are shared—can materially affect tax outcomes.

 Need for Expert Advice: Given the complexity of these issues, it is advisable for taxpayers to seek guidance from professionals experienced in both U.S. tax law and the relevant foreign legal systems.

In essence, while a usufruct arrangement might simplify the division of rights under foreign law, its U.S. tax implications are multifaceted. Both income and transfer tax consequences must be evaluated in light of the arrangement’s detailed terms, making expert consultation a vital part of effective estate and tax planning.

For customized tax advice, contact Christine Alexis Concepción at caconcepcion@concepcionlaw.com

Part I: A Primer on Usufructs and Their Treatment by the IRS

In the complex world of tax law, unique property rights often create uncertainty, especially when navigating international tax and estate planning. One such concept that arises in civil law jurisdictions but is less familiar in common law countries like the United States is the usufruct.

Understanding its legal implications and how it is treated by the IRS is essential for international tax professionals and individuals dealing with cross-border tax and estate planning.

What is a Usufruct?

A usufruct is a legal arrangement in which one party (the usufructuary) has the right to use and enjoy the benefits of an asset while another party (the bare owner) retains ownership of the underlying property. This structure is commonly used in countries with civil law systems, such as France, Spain, and Louisiana in the U.S.

In practical terms, a usufructuary can live in a property, lease it out, or generate income from it without holding full legal ownership. Upon the expiration of the usufruct—either due to the usufructuary’s death or the completion of a predetermined term—full ownership reverts to the bare owner.

IRS Treatment of Usufructs

The U.S. tax system does not explicitly recognize usufructs in the same way as civil law jurisdictions. However, the IRS typically treats them based on their economic substance rather than their formal classification. Some key considerations include:

1. Estate and Gift Tax Implications:
   — When a usufruct is granted, the IRS may consider it a transfer of a present interest in property. If a U.S. taxpayer receives a usufruct from a non-U.S. person, the IRS might treat the value of the usufruct as a gift subject to U.S. gift tax regulations.

   — If the usufructuary dies, the IRS may include the usufruct’s value in their taxable estate, depending on the circumstances.

2. Income Tax Considerations:
   — The usufructuary is generally considered the beneficial owner of the property for income tax purposes. Any rental income or other earnings derived from the usufruct are taxable to the usufructuary under U.S. tax law.

   — Depreciation deductions, where applicable, might also be available to the usufructuary.

3. Step-Up in Basis Issues:
   — One major question in estate planning involving usufructs is whether the bare owner receives a step-up in basis upon the usufructuary’s death. The answer often depends on how the IRS classifies the arrangement, whether as a life estate or another structure.

Key Considerations for U.S. Taxpayers

For U.S. persons inheriting or receiving property interests through a usufruct, it is crucial to:

• Consult with a tax attorney or advisor familiar with cross-border estate planning.

• Determine whether any U.S. tax filing obligations arise from the usufruct (such as Form 3520 for foreign gifts or trusts).

• Understand potential reporting requirements related to foreign assets.

Final Thoughts

While usufructs offer valuable estate planning advantages in civil law jurisdictions, they introduce unique tax challenges for U.S. persons. Given the IRS’s focus on the substance of an arrangement rather than its form, taxpayers must ensure compliance with U.S. tax laws when dealing with usufructuary rights.

Proper planning and expert legal guidance can help mitigate risks and optimize tax outcomes in these situations.

For customized tax advice, contact Christine Alexis Concepción at caconcepcion@concepcionlaw.com