WHAT’S A USUFRUCT? How is it treated by the IRS?

Usufruct is a limited real right (or in rem right) found in civil-law and mixed jurisdictions that unites the two property interests of usus and fructus:

Usus (use) is the right to use or enjoy a thing possessed, directly and without altering it.
Fructus (fruit, in a figurative sense) is the right to derive profit from a thing possessed: for instance, by selling crops, leasing immovables or annexed movables, taxing for entry, and so on.

A usufruct is either granted in severalty or held in common ownership, as long as the property is not damaged or destroyed. The third civilian property interest is abusus (literally abuse), the right to alienate the thing possessed, either by consuming or destroying it (e.g., for profit), or by transferring it to someone else (e.g., sale, exchange, gift). Someone enjoying all three rights has full ownership.

Generally, a usufruct is a system in which a person or group of persons uses the real property (often land) of another. The “usufructuary” does not own the property, but does have an interest in it, which is sanctioned or contractually allowed by the owner. Two different systems of usufruct exist: perfect and imperfect. In a perfect usufruct, the usufructuary is entitled the use of the property but cannot substantially change it. For example, an owner of a small business may become ill and grant the right of usufruct to an individual to run their business. The usufructuary thus has the right to operate the business and gain income from it, but does not have the right to, for example, tear down the business and replace it, or to sell it. The imperfect usufruct system gives the usufructuary some ability to modify the property. For example, if a land owner grants a piece of land to a usufructuary for agricultural use, the usufructuary may have the right to not only grow crops on the land but also make improvements that would help in farming, say by building a barn. However this can be disadvantageous to the usufructuary: if a usufructuary makes material improvements – such as a building, or fixtures attached to the building, or other fixed structures – to their usufruct, they do not own the improvements, and any money spent on those improvements would belong to the original owner at the end of the usufruct

In many usufructuary property systems, such as the traditional ejido system in Mexico, individuals or groups may only acquire the usufruct of the property, not legal ownership. A usufruct is directly equatable to a common-law life estate except that a usufruct can be granted for a term shorter than the holder’s lifetime.

There is little U.S. law addressing the taxation of usufructs. Only the state of Louisiana, which follows civil law, recognizes a usufruct. No other U.S. state recognizes usufructs. So how does the United States treat such usufruct arran- gements? This article will examine the usufruct, how the United States taxes it, and how the rules apply in practice.

What are the rights of the usufruc- tuary? The usufructuary has the right to use the property and is entitled to income from the property. The usufructuary’s interest is generally similar to a life estate under common law.

How and when is it taxed? The tax treatment of a usufruct arrange- ment depends on the facts and circumstances of each arrangement. A usufructuary typically is taxed on the income earned by the property. When a usufruct arrangement is created, a gift of the bare property interest gene- rally is treated as made. This gift may be subject to U.S. gift tax, but the value of the gift may be limited to the value of the bare property interest.

What is the nature of the right of the bare owner? The “naked” or “bare” owner (equivalent to a remainderman in a common law jurisdiction) is the legal owner of the property. Upon the usufructuary’s death, the usufructuary’s interest is automatically transfer- red to the bare property owner who then owns the property in full.

How and when is it taxed? If the usufructuary is a U.S. person, then the value of property subject to a usufruct arrangement generally is included in the usufructuary’s estate for U.S. estate tax purposes if the usufructuary was the one who created the usufruct and gave the bare ownership. In that case, the bare property owner generally receives a tax basis in the property


A usufruct may be treated as a life estate (or form of co-ownership), because there is no separate fiduciary or title owner, or under the U.S. treasury regulations, an ordinary trust. The Internal Revenue Service (the “IRS”) has issued private letter rulings (PLRs) in which it characterized a usufruct as a trust for income tax purposes. For example, in PLR 9121035, the IRS concluded that a usufruct was classified as a trust for U.S. tax purposes. In the ruling, the usufructuary, in addition to his usufruct rights, had administrative powers over the assets subject to the usufruct (similar to the role of a trustee). It is possible that the IRS would not treat a usufruct as a trust for income tax purposes if the usufructuary did not have administrative powers similar to those in the letter ruling.

Regardless of whether a usufruct is treated as a form of co-ownership (e.g., a life estate) or a trust for U.S. tax purposes, if the usufructuary owns interests in non-U.S. entities, the individuals holding bare interests in the usufruct arrangement may not be subject to U.S. income tax or U.S. income tax reporting obligations. Generally, individuals holding a bare interest in an entity have no interest in the income, and therefore, depending on the circumstances, such individuals may not be subject to U.S. income tax or reporting obligations with respect to such an entity.

For example, in PLR 8748043, the IRS concluded that a usufructuary of a Netherlands usufruct was considered the owner of the underlying stock until the usufruct period ended. Under Dutch law, the usufructuary was entitled to the use and enjoyment of assets subject to the usufruct during the usufructuary’s lifetime, but the usufructuary was obligated to preserve intact the underlying property. Upon the usufructuary’s death, the usufruct terminated and all rights with respect to the property were thereafter enjoyed by the remaindermen. In addition, in the case of this usufruct imposed on stock, any dividends paid during the term of the usufruct by the corporation with respect to its stock must have been paid to the usufructuary and no dividends could be paid to the remaindermen.

The PLR analyzed whether the usufructuary or the remaindermen was treated as the owner of stock subject to the usufruct arrangement for applying the United States controlled foreign corporation (“CFC”) rules. These rules generally provide that the determination of a person’s proportionate interest in a non-U.S. corporation be made based on all the facts and circumstances in each case. A person’s proportionate interest in a non-U.S. corporation generally will be determined with reference to such person’s interest in the income of the corporation, but any arrangement that artificially decreases a U.S. person’s proportionate interest will not be recognized. The IRS reasoned that because the usufructuary had a 100 percent interest in the corporation’s income during the usufruct’s term, the usufructuary was treated as the owner of the corporate stock during such time for purposes of the CFC rules. It is possible, however, that the IRS would take a contrary position. In addition, although not free from doubt, bare ownership likely is reportable on IRS Form 8938 (State- ment of Specified Foreign Assets) – especially where the bare property interest holder is entitled to liquidation rights


A typical French succession plan often invol- ves the client retaining a usufruit or usufruct interest and giving the nue propriété or bare ownership to the next generation. The benefits from a French perspective are typically that the value of the gift on which French gift tax will be paid is reduced based on the age of the donor. At the donor’s subsequent death, the usufruct interest evaporates and “poof” nothing is included in the usufructuary’s estate to be taxed at death. Thus, the appreciated value all passes entirely to the bare property owner at the usufructuary’s death, typically the usufructuary’s child.

Firstly, the concept of a usufruct is little known in the U.S. law. Thus, the arrangement is likened to other more familiar U.S. concepts namely, either a trust or a life estate/remainder interest depending on the characteristics of the arrangement. Typically, French usufructs are treated as life estates and bare property interests as remainder interests. A transfer by the donor (usually a parent) of the bare property ownership interest to the donee (often a child) could give rise to U.S. income, gift and estate tax reporting requirements depending on the asset in question (shares in a company or real property) and who is making the transfer (such as a U.S. citizen/domiciliary or a non-U.S. citizen, non U.S. domiciliary (NCND).

If the donor is a U.S. citizen residing in France (or a U.S. resident transferring a bare ownership interest in French property), the donor will be subject to U.S. estate tax at the time of death. This is because the United States views the donor as not relinquishing the entire property but retaining a string, which is the usufruct interest. As such, the United States does not treat the gift as a completed gift but as a gift with a retained interest resulting in the full fair market value of the asset at death being inclu- dible in the U.S. person’s estate and subject to U.S. estate tax. Furthermore, there is no credit for the gift tax paid to France in the earlier year of transfer unless the individual also paid U.S. gift tax, which would only occur if the lifetime transfers exceeded the exemption amount


The U.S. bare property owner may have additional U.S. reporting obligations. These include, but are not limited to, the following:

  • Form 3520 (Annual Return to Report Transac- tions with Foreign Trusts and Receipt of Certain Foreign Gifts) – This reporting is required if the value of the gifted bare property ownership interest from a non-U.S. person exceeds the filing threshold ($100,000 if from an individual).
  • Form 8938 (Statement of Specified Foreign Financial Assets) – This reporting could be required annually if the bare property interest is in a “specified foreign financial asset” and would require reporting the value of the U.S. person’s bare property interest on an annual basis with her U.S. tax return.
  • Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) – This form may be required to be filed if the bare property interest is in a foreign holding com- pany classified as a foreign partnership for U.S. tax purposes. An example of such an entity is an SCI – which generally is treated as a foreign partnership for U.S. tax purposes without elec- ting other treatment
  • Form 5471 (Return of U.S. Persons With Respect to Certain Foreign Corporations) – This form may be required to be filed if the bare property interest is in a foreign holding company classified as a foreign corporation for U.S. tax purposes. An example of such an entity is an SA – which is treated as a “per se” foreign corporation for U.S. tax purposes

Key Points

  1. Usufructs are used for estate and tax planning purposes in many civil law countries such as Italy, France, Germany and Brazil, and under Louisiana law (see Rev. Rul. 64-249, 1964-2 C.B. 332).
  2. The intended purpose of a usufruct is the separation of legal title of property from the right to use and enjoy the property in order to achieve certain local tax efficiencies, such as the reduction of local inheritance tax. 
  3. Under a usufruct, a person (the “usufructuary” or “donor”) generally transfers “bare title” in property to another person (the “titleholder” or “donee”), while reserving the current rights to use and enjoyment of property for a term of years or measuring life as a usufructuary.
  4. No exact comparable concept under U.S. law—similar to a common law life estate, but not quite the same—see, e.g., Rev. Rul. 66-86, 1966-1 IRB 216.
  5.  IRS private letter rulings differ regarding whether a usufruct is a “trust” for U.S. tax purposes depending upon the related facts and circumstances —see PLRs 9121035 (Germany-yes) and 201032021 (“Country”). 
  6. We often encounter U.S. children of a foreign parent who have received or are contemplating receiving a gift of a “naked legal title” interest in offshore property.
  7. Does the U.S. donee have to report the gift on Form 3520? The U.S. person did receive a gift—the issue is valuation. The gift must be reported on Form 3520 if it exceeds $100,000, either by itself or when aggregated with other gifts made in the same year by related NRAs and foreign estates.
  8. If so, how should the U.S. donee report the gift? The gifted property should be described as a usufruct interest in the described property under local applicable law. 
  9. If the transfer was unreported when made in a prior tax year, how should the U.S. donee handle late reporting?  If the donee’s failure to report was non-willful, consider the IRS Streamlined Offshore Procedures, although other methods may also be available. 
  10. How should the gift be valued for U.S. gift tax purposes? Engage an expert in the donor’s local jurisdiction to obtain an appraisal, taking into account (as one factor) the valuation of the gift on the donor’s home country tax return (if any).
  11. What if the gift is stock of a foreign corporation or an interest in a foreign partnership?  Consider for an FC whether it should be treated as a CFC or a PFIC depending upon the rights transferred.
  12. Consider the potential need to file any applicable U.S. reporting forms (5471, 8865, 8938, FBAR, etc.)
  13.  Consider the possibility of a check-the-box election on Form 8832 effective prior to the gift to classify the foreign company as a pass-through entity
  14. Does a U.S. naked legal title donee have to pick up and report any income or gains relating to the property?  Arguably not, so long as the foreign donor retains these rights. 
  15. Does the donee of a usufruct interest receive a basis step-up (or down) to fair market value upon the death of the donor, when the entire transfer becomes legally complete? Various practitioners have believed (and still believe) that property so held in an irrevocable grantor trust should be treated as acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent for purposes of IRC § 1014(a)(1). This issue has been a “no ruling” IRS area.  In contrast, this ruling held that no such basis adjustment for the trust asset occurs upon the death of the settlor/grantor of a completed-gift irrevocable grantor trust because:

(1) the trust asset was not includible in the settlor/grantor’s gross estate;

(2) It had not been acquired from or passed from the decedent for purposes of IRC § 1014(a); and

(3) It did not fall within any of the remaining types of property listed in IRC § 1014(b).

Without so stating, this ruling reverses PLR 201245006, which involved a irrevocable foreign

grantor trust with a foreign settlor, with the IRS holding that its assets would pass by bequest,

devise, or inheritance upon the settlor’s death under IRC § 1014(b)(1).

  1. Treas. Reg. § 1.1014-2(a)(1) provides that property acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent, whether the property was acquired under the decedent’s will or under the law governing the descent and distribution of the property of decedents, is considered to have been acquired from a decedent, and the property’s basis is determined under the general rule in Treas. Reg. § 1.1014-1.  
  2. The IRS stated that upon the settlor/grantor’s death, the trust asset was not ”bequeathed,” “devised,” or “inherited” within the meaning of § 1014(b)(1).” As support for this position, the IRS cited two cases reviewing related state law definitions: (1) Bacciocco v. United States, 286 F.2d 551, 554-55 (6th Cir. 1961), where the court held that property transferred in trust prior to the decedent’s death was not “bequeathed” or “inherited” because it did not pass either by will or intestacy; and (2) Collins v. United States, 318 F. Supp. 382, 385-386 (C.D. Cal. 1970), where the court stated, “[i]t seems clear that property cannot be said to come from a decedent by ‘bequest, devise, or inheritance’ unless it is part of the decedent’s probate estate under the laws of the state of his domicile.”
  3. In contrast, footnote 4 stated “This revenue ruling does not alter the result in Rev. Rul. 84-139. Property acquired from a non-resident non-citizen decedent that is not included in his or her gross estate may receive a basis adjustment under § 1014 if the property is acquired by bequest, devise, or inheritance within the meaning of § 1014(b)(1) or is otherwise specifically described in § 1014(b).”
  4. Rev. Rul. 84-139 has been extensively used for international tax planning and estate planning purposes. In this ruling, D, a citizen and resident of foreign country Z, died owning real property located in Z. B, a United States citizen, inherited the real property. At the time of D’s death, the property had a basis of $100x and a FMV of $1,000x. As foreign real estate owned by D was a nonresident alien, the value of the property was not includible in D’s gross estate under IRC § 2103. B sold the property the following year for $1050x, claiming a basis of $1,000x and gain of $50x. The ruling concludes that, because B inherited the property from D, and the property is within the definition of property acquired from a decedent under IRC § 1014(b)(1), it received a basis adjustment to FMV at D’s death because it was acquired by a bequest.
  5. A usufruct interest should not be subject to U.S. estate tax upon the donor’s passing because it relates to non-U.S. situs property owned by a nonresident alien domiciliary.  
  6. For an irrevocably-created usufruct interest, notwithstanding the lack of an applicable U.S. estate tax upon the donor’s passing, could the donee take the position that it was acquired by bequest, devise, or inheritance within the meaning of § 1014(b)(1) and thus entitled to a basis step-up?  If you do take a related basis step-up position, do you need to “red flag” it by filing IRS Form 8275 or 8275-R?

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