Estate Planning Opportunities for Real Estate Owners

Estate Planning Opportunities for Real Estate Owners

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Owners of real estate are in a unique position as it relates to estate planning opportunities. They are able to employ various strategies to minimize their tax burden as they begin to transfer their assets. The goal of a good estate plan is to reduce the overall estate and gift taxes that an individual will be responsible for, or to defer the tax burden. Considerations that must be taken into account while developing a good estate plan are the need for liquidity and the taxpayer’s need to retain control of their various assets.

The transfer of wealth may be done either during an individual’s lifetime or afterwards. If done during an individual’s lifetime, any transfers will be subject to gift tax. The gift tax is a tax imposed on the transfer of property and applies to all direct and indirect transfers. There are several exclusions to gift tax, such as the $14,000 per year annual exclusion per donee (2015 amount). Other exclusions to gift tax include gifts made to one’s spouse and amounts paid directly as tuition or medical care on behalf of any individual.

Any assets not transferred during lifetime and still owned by an individual at death will be subject to the estate tax. Currently, there is a unified credit against estate and gift taxes in the amount of $5,430,000 (2015 amount, indexed annually for inflation). An individual will be subject to estate tax based on the amount that their gross estate exceeds their unused lifetime exclusion. The maximum estate tax rate is 40%.

Two strategies that can help to minimize the tax burden when transferring real estate are utilizing valuation discounts on the transfer of interests and freezing the value of assets for estate tax purposes.

Discounts can be given for lack of marketability, the lack of control associated with holding a minority interest in an entity. This can easily be done by moving real estate assets into a partnership entity and then transferring interests in the partnership. A discount for lack of marketability relates to the degree of the transferred interest’s liquidity, either due to timing restrictions or because any liquidation value will not be at full fair market value. The discount for lack of marketability stems from a comparison between the membership interest in question and similar assets that carry greater liquidity. Discounts for holding a minority or non-controlling interest reflect minority owner’s control in the entity. In order to support the use of discounts, the partnership must have a qualified appraisal done. The appraisal will evaluate the relevant factors and support the amount of the discount against future challenges.

In order to freeze the value of property for estate tax purposes, an individual would consider intrafamily transfers. Sales can be made directly to family members or to a grantor trust formed by the individual. If assets are transferred at their current fair market value (subject to the discounts discussed above), there would be no gift tax concerns. Intrafamily transfers done at a reduced value could have gift tax implications. Intrafamily sales can serve a few concerns for real estate entrepreneurs looking to address estate tax concerns. First, any future appreciation in the real estate is outside of the estate. The value of the asset as it relates to the individual’s estate is locked on the date of the transaction. Second, assuming the sale is done for a promissory note, the sale can provide future cash flow to the individual. Cash flow is usually a concern for real estate entrepreneurs when they consider transferring away real estate assets. Last, an intrafamily sale may allow assets to be transferred to a younger generation without the additional tax burden of any Generation Skipping Tax.

Aside from the traditional estate planning aspects, a real estate owner should also be aware of other important pieces they may be missing from their plan. It is important to have a succession plan in place to ensure that the business continues and in the way in which the taxpayer intends. A lot of real estate businesses are family businesses, and it is important that family members that will be continuing the business are well equipped to do so. A succession plan will also help to prevent conflicts about the direction the business should go in.

Asset protection from divorce, liability, and creditors is also important. Choosing the right type of entity can help to protect assets after the taxpayer is gone. Liquidity is often another concern for real estate owners that don’t want their heirs to have to sell the properties in order to pay the estate taxes. A good insurance policy should help to cover any tax needs and allow the heirs to hold on to the properties.

Sara Palovick Sara Palovick, CPA
[email protected]

Sara Palovick, CPA

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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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