What Is IRC Section 2036? When Does IRC §2036 Include Assets in Your Estate? What Is the Estate of Strangi Case? How Can Retained Control Trigger Estate Taxes

IRC Section 2036 includes assets in a decedent’s gross estate if they transferred property but retained an interest in or control over it until death, preventing tax avoidance through inter vivos transfers while maintaining benefits. This provision is critical for effective estate tax planning, especially for high-net-worth individuals.

Key Takeaways

IRC Section 2036 Purpose: Prevents taxpayers from reducing their taxable estate by transferring assets while still enjoying or controlling them.
Retained Interests: Assets are pulled back into the estate if the decedent retained possession, enjoyment, or the right to income from the transferred property.
Retained Control: The right to designate who possesses or enjoys the property or its income can also trigger inclusion under IRC Section 2036.
Estate of Strangi: This landmark case clarified that lack of a legitimate non-tax purpose for a family limited partnership (FLP) and retained control by the decedent could cause assets transferred to the FLP to be included in the gross estate.
Bona Fide Sale Exception: An exception exists if the transfer was a bona fide sale for adequate and full consideration in money or money’s worth.
OBBB Impact: While the “One Big Beautiful Bill” (OBBB) updated general tax law, the fundamental principles of IRC Section 2036 regarding retained interests remain a cornerstone of estate tax enforcement for 2026.

By Sid Peddinti, Esq.

Issue: The Central Question of Retained Interests and Estate Tax Planning

The central issue in estate tax planning often revolves around the effectiveness of inter vivos transfers – gifts made during a donor’s lifetime – to reduce a decedent’s gross estate for federal estate tax purposes. Specifically, the critical legal question is whether assets transferred by a decedent during their lifetime, particularly into vehicles like family limited partnerships (FLPs), should be included in their gross estate under IRC Section 2036 due to the decedent having retained possession, enjoyment, or the right to income from the property, or having retained the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or its income. This issue frequently arises when the transferred assets are not considered a “bona fide sale for an adequate and full consideration in money or money’s worth,” and the transferor maintains a significant level of control or benefit from the transferred property, as dramatically illustrated in the seminal case of Estate of Strangi v. Commissioner. Estate tax planning seeks to minimize tax liabilities while respecting the intent of the transferor, making the precise application of IRC Section 2036 a paramount concern for clients and practitioners nationwide.

Rule: Understanding IRC Section 2036 and its Application to Estate Inclusion

What is IRC Section 2036?

Internal Revenue Code (IRC) Section 2036, titled “Transfers with Retained Life Estate,” mandates the inclusion of certain transferred property in a decedent’s gross estate. It stipulates that the value of any interest in property that the decedent has transferred (except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which they have retained for life, or for any period not ascertainable without reference to their death, or for any period that does not in fact end before their death – (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom, shall be included in the decedent’s gross estate.

Why was IRC Section 2036 Enacted?

Congress enacted IRC Section 2036 to prevent taxpayers from circumventing estate taxes by making lifetime transfers of property while essentially retaining the economic benefits or control over that property until death. The legislative intent was to ensure that property truly removed from an individual’s dominion before death would avoid estate tax, but that property where the transferor continued to enjoy or control it as if they still owned it, would not escape taxation. It addresses situations where a transfer appears complete on paper but the transferor’s relationship to the property remains substantially unchanged, thereby preventing what are effectively testamentary dispositions from being treated as completed inter vivos gifts for estate tax purposes.

When are Assets Included in a Taxable Estate under IRC Section 2036?

Assets are included in a taxable estate under IRC Section 2036 if three conditions are met: (1) there was an inter vivos transfer of property by the decedent, (2) the transfer was not a bona fide sale for adequate and full consideration, and (3) the decedent retained either possession or enjoyment of, or the right to income from, the transferred property, or the right to designate who would possess or enjoy the property or its income. The retained interest or right must have existed for the decedent’s life, for a period not ascertainable without reference to their death, or for a period that did not in fact end before their death.

What Constitutes “Retained Control” or Enjoyment?

“Retained control” or “enjoyment” under IRC Section 2036 can encompass a broad range of circumstances beyond explicit contractual rights. It can include implicit understandings or informal agreements where the decedent continues to benefit from the transferred property. Examples include continuing to live in a residence transferred to children without paying rent, using transferred funds for personal expenses, or having unrestricted access to assets nominally held by a partnership or trust. “The right… to designate the persons who shall possess or enjoy the property or the income therefrom” includes situations where the decedent, acting as a trustee or general partner, retains the power to control the distribution of income or principal. This broad interpretation ensures that substance over form prevails in assessing whether a decedent truly relinquished control and enjoyment.

The “Bona Fide Sale for Adequate and Full Consideration” Exception

A crucial exception to IRC Section 2036 inclusion is for transfers that constitute a “bona fide sale for an adequate and full consideration in money or money’s worth”. For this exception to apply, two main requirements must be met: (1) the transfer must be a “bona fide sale,” meaning it must be made in good faith with a legitimate and significant non-tax reason, and (2) the consideration received by the transferor must be “adequate and full,” meaning it must be roughly equivalent to the fair market value of the property transferred. In the context of family limited partnerships (FLPs), the “bona fide sale” aspect is particularly scrutinized. The courts look for a “legitimate and significant non-tax reason” for the entity’s formation and the property transfer, such as active business management, asset protection from creditors, or resolution of potential disputes among family members. A mere recycling of value, where assets are transferred to an entity and partnership interests are received in return, may not qualify if the underlying purpose is primarily tax avoidance without demonstrable non-tax benefits. Furthermore, if the transferor continues to use the assets or access them freely, it undermines the “bona fide” nature of the sale.

The “One Big Beautiful Bill” (OBBB) Context

As of 2026, the federal tax landscape is shaped by the “One Big Beautiful Bill” (OBBB), signed in 2025. While the OBBB significantly updated various tax provisions, including estate tax exemptions and rates, the fundamental principles of IRC Section 2036 regarding retained interests and control remain a critical component of estate tax law enforcement. The OBBB did not alter the core statutory language or judicial interpretations of IRC Section 2036 itself; rather, it adjusted the financial thresholds and overarching tax environment within which these rules are applied. Therefore, estate tax planning professionals and high-net-worth families must continue to meticulously consider IRC Section 2036’s implications, as the scrutiny of retained interests in transferred assets remains as stringent under the OBBB as under prior tax legislation. Any planning strategies must account for these enduring principles to avoid unintended estate inclusion.

Analysis: Applying IRC Section 2036 to Estate of Strangi and Common Planning Scenarios

The Estate of Strangi Case: A Landmark for IRC Section 2036

The case of Estate of Strangi v. Commissioner, decided by the Tax Court in 2003 and affirmed in part by the Fifth Circuit in 2005, stands as a pivotal ruling regarding IRC Section 2036 and the use of family limited partnerships (FLPs) in estate tax planning. Albert Strangi, prior to his death, transferred substantially all of his wealth, including real estate and marketable securities, to an FLP and a related limited liability company (LLC) formed shortly before his death. In return, he received a 99% limited partnership interest and 47% interest in the LLC, which served as the general partner. His children owned the remaining interests. Strangi’s son-in-law, acting under a power of attorney for Strangi, managed the FLP and LLC. Strangi continued to reside in his transferred home, and the FLP paid for his medical expenses and funeral costs.

The IRS challenged the exclusion of these transferred assets from Strangi’s gross estate, arguing that IRC Section 2036 applied because Strangi had retained possession and enjoyment of the transferred property, and implicitly retained control over the assets through his son-in-law’s actions and his position as the majority limited partner. The Tax Court initially applied IRC Section 2036(a)(1) (retained enjoyment) and later, upon remand from the Fifth Circuit, also applied IRC Section 2036(a)(2) (retained right to designate who possesses or enjoys).

How Retained Control Triggered Estate Taxes in Strangi

The core of the Strangi decision hinged on the court’s finding that the transfer of assets to the FLP and LLC did not qualify as a “bona fide sale for adequate and full consideration” and that Strangi had indeed retained enjoyment and control. The Tax Court found that the FLP lacked a legitimate and significant non-tax purpose. Despite claims of non-tax motives such as asset protection, centralized management, and dispute resolution, the court viewed these as subordinate to the estate tax savings. For example, the court noted that Strangi’s personal needs were met directly from the FLP’s funds, demonstrating an implicit agreement that he would continue to enjoy the transferred assets. This effectively negated any genuine transfer of enjoyment.

Regarding retained control under IRC Section 2036(a)(2), the court focused on the decedent’s implicit ability, through his son-in-law acting as general partner and under a durable power of attorney, to control the distribution of the FLP’s income and assets. Even though Strangi was a limited partner, the practical reality was that the FLP’s actions were dictated by someone acting on his behalf and for his benefit, indicating a retained right to designate who would enjoy the property. The court emphasized that the lack of true separation between Strangi’s personal finances and those of the FLP, coupled with the lack of genuine non-tax motives, rendered the transfer ineffective in removing the assets from his gross estate under IRC Section 2036. This case firmly established that courts would look beyond the formal structure of an entity to the practical realities of control and enjoyment.

Common Planning Mistakes and IRC Section 2036 Pitfalls

The Strangi case, and subsequent rulings, highlight several common mistakes that can trigger IRC Section 2036 inclusion in estate tax planning:

Lack of Legitimate Non-Tax Purpose: Forming an entity like an FLP solely or primarily for estate tax reduction, without demonstrable non-tax business or financial objectives, is a significant red flag. Courts scrutinize the reasons for forming such entities.
Co-Mingling of Funds: Treating the entity’s assets as personal assets, such as using partnership funds to pay personal expenses or failing to keep adequate books and records, clearly indicates retained enjoyment.
Disproportionate Distributions: Making distributions from the entity based on personal needs rather than proportionate to ownership interests signals retained enjoyment and control.
Retention of Sufficient Assets Outside the Entity: If the transferor divests almost all liquid assets into the entity, leaving insufficient funds for personal living expenses, it suggests an implicit agreement to draw on the entity’s assets, triggering IRC Section 2036.
Decedent as Sole General Partner/Trustee: Retaining sole control as the general partner of an FLP or the sole trustee of a trust, with broad discretionary powers over distributions, almost guarantees inclusion under IRC Section 2036(a)(2).
Timing of Formation and Funding: Forming an entity when the transferor is elderly, in poor health, or shortly before death, particularly if assets are transferred in a rush, raises suspicions about the primary motive.

Who is Most Affected by IRC Section 2036?

IRC Section 2036 primarily affects high-net-worth families and individuals engaging in sophisticated estate tax planning, especially those utilizing vehicles such as family limited partnerships (FLPs), limited liability companies (LLCs), or trusts to transfer wealth while potentially retaining some form of access or control. Estate tax planning professionals nationwide must advise these clients carefully to ensure their strategies comply with the “bona fide sale” exception and avoid the pitfalls of retained interests. Those with significant illiquid assets, such as real estate or closely held business interests, who wish to consolidate management or achieve valuation discounts, are particularly susceptible to scrutiny under this section if the transfers are not structured correctly.

Latest IRS Guidance for Estate Planning Professionals

While the specific dollar thresholds for estate tax exemptions are adjusted annually under the One Big Beautiful Bill (OBBB) and other legislative directives, the fundamental principles governing IRC Section 2036 remain consistently applied by the IRS. Recent guidance from the IRS and Treasury, often communicated through Revenue Rulings, Notices, and Chief Counsel Advice, continues to emphasize the importance of substance over form in evaluating transfers with retained interests. The IRS consistently targets arrangements where taxpayers attempt to achieve significant estate tax discounts by transferring assets to entities while functionally retaining control or enjoyment. They often scrutinize the “bona fide sale” exception, particularly the presence of a “legitimate and significant non-tax reason” for the entity’s creation and funding, and whether the transferor received “adequate and full consideration”. Planners are advised to document all non-tax motivations thoroughly, ensure strict adherence to entity formalities, avoid co-mingling of funds, and establish a clear economic purpose for the entity independent of tax reduction. Furthermore, any powers retained by the transferor, directly or indirectly, that could impact the beneficial enjoyment of the transferred property should be carefully reviewed to prevent IRC Section 2036 inclusion.

Conclusion: Navigating Retained Interests in Modern Estate Planning

In conclusion, IRC Section 2036 remains a formidable tool for the IRS in preventing the erosion of the federal estate tax base through transfers with retained interests. The Estate of Strangi case serves as a stark reminder that courts will meticulously examine the practical realities of asset transfers, looking beyond formal legal structures to the underlying substance of the decedent’s relationship with the transferred property. For a transfer to effectively remove assets from a decedent’s gross estate, it must genuinely divest the transferor of both the enjoyment and control of the property. This necessitates ensuring that any transfer, particularly to entities like FLPs, satisfies the “bona fide sale for adequate and full consideration” exception, which requires a legitimate and significant non-tax purpose and proper economic exchange. Estate tax planning professionals, serving clients nationwide, must meticulously structure transactions, document non-tax motivations, and ensure strict adherence to formalities to avoid the pitfalls of retained enjoyment or control. Under the current tax environment shaped by the One Big Beautiful Bill (OBBB), the vigilance surrounding IRC Section 2036 is more critical than ever, demanding a thorough understanding and application of its principles to achieve effective and compliant estate tax planning strategies.