The East End is a legacy community where families summer by the ocean, bay and wineries for continual generations. These families engage in strategic succession planning, whereby a trust, as an essential planning tool, is generally the best vessel to pass one’s Hamptons or North Fork real estate onto the next generation. A trust can address both federal and New York State estate tax issues, which can be crippling if ignored.
New York State taxes estates valued over $4,187,500 in 2016 at a rate that can reach up to 16%. In addition to New York State’s estate tax, the federal government taxes estates over $5,450,000 in 2016 at a rate that can reach up to 40%. So all individuals who don’t want their family’s summer home to fall victim to the tax collector must consider how best to pass their legacy onto the next generation.
Even with lower real estate valuations, trusts remain an essential succession-planning tool because they can prevent creditors from seizing certain properties and can control future generations from engaging in an undesired liquidation of the family’s home. This is the list of 5 of the more common trusts used by East Enders.
QTIP stands for a qualified terminable interest property trust. This trust enables an owner to allow his or her surviving spouse to maintain use of the property for her or his remaining lifetime but dictates that the trust’s property goes onto the next generation upon the second-to-die spouse’s death. It’s a terrific vessel for an individual in a second marriage who desires to protect both the spouse and children. In fact, this vessel is optimal where an individual loves his or her spouse but does not feel comfortable in blindly trusting that spouse’s future decision-making in protecting the first-to-die’s children. Many surviving spouses can outlive the first-to-die by decades and may remarry, find a religion to which they dedicate their life (and assets on death), or simply lose interest in stepchildren during the years before their own demise.
CST stands for a credit shelter trust. This trust enables an individual to combine his or her New York State estate tax exemption, $4,187,500, with that of his or her spouse for a total of $8,375,000 in exemptions. As a result, a CST can cause no estate tax to be due where a couple has total assets of under $8,375,000 and the spouses separated their assets equally pre-death. With respect to federal estate tax, a CST is not required because of a concept called portability, whereby the executor of the estate files a timely Form 706 to join the spouse’s federal exemptions of $5,450,000 to a total exemption of $10,900,000. However, without a CST and through the use of portability, the appreciation of assets will be subject to federal estate taxes, whereas a CST has the added benefit of freezing assets at their value at the time that the trust was funded as opposed to the date of death valuations. So, even with the federal portability concept, a CST proves advantageous where assets are appreciating, such as real estate on the East End.
A spendthrift trust is designed for a beneficiary who can’t control his or her spending. This trust prevents the beneficiary from transferring his or her rights to future payments of income or the corpus (i.e., the house) to a creditor for value. With a spendthrift trust for a vacation home, the trustee can rent the home for months during the season to third-party tenants while limiting the beneficiary’s use to a rental period relative to the accumulated income from the rentals and the operating costs for maintaining the property (i.e., payment for the beneficiary’s use).
QPRT stands for a qualified personal residence trust, which is established pursuant to 26 CFR 25.2702-5(c). Under this trust, the settlor (i.e., person forming the trust) places their residence into a trust during their lifetime while continuing to live in that residence rent-free. If the settlor outlives the trust’s set duration (i.e., term), then no estate tax is ever due on transferring the residence to the trust’s beneficiaries and the settlor can nonetheless continue living in the property for the remainder of his or her lifetime. If, however, the settlor does not outlive the term of the trust, then estate tax is due and the previously paid gift tax is forgiven. For East Enders, this is typically the best trust option because a QPRT works for either the settlor’s principal residence or a second residence (e.g., summer home) and a married couple can have up to three QPRTs. The advantage of this trust is that a residence can be transferred to beneficiaries while freezing the future appreciation of the property (i.e., paying estate / gift tax; federal gift tax is taxed at 40%, but New York State does not have state gift tax) on today’s fair market value, not at the date-of-death fair market value. Further, the gift tax due on funding the trust is not based upon the full fair market value of the house on the date of transfer but instead is a far reduced sum that is determined based upon the duration that the trust is set to remain in existence, the life expectancy of the settlor, and a set interest rate from IRC §7520 (i.e., valuation tables of the tax code). Under a QPRT, an East End family can summer for future generations.
PRT stands for a personal residence trust, which is established pursuant to 26 CFR 25.2702-5(b). Like a QPRT, the settlor (i.e., person forming the trust) places their residence into a trust during their lifetime while continuing to live in that residence rent-free into the future. However, unlike a QPRT, a PRT can be terminated before the end of the trust’s term where the residence’s ownership will be split into a joint ownership interest, as tenants in common, between the settlor and beneficiaries. The apportionment of the tenants in common ownership interests is based upon the valuation of the remaining term and the valuation of the remainder interests. The reasons to terminate the trust vary, but the main reason is where it’s unexpected that the settlor will outlive the trust’s term and an alternative planning strategy is advantageous under those facts. Another dissimilarity between a QPRT and PRT is that where a QPRT may be rented to third parties so long as the settlor uses the property for a minimum of the greater of 15 days or a time period that exceeds 10% of the number of days during such year for which such unit is rented at a fair rental (See IRC 280A(d)(1)), a PRT can only be occupied by the settlor, the settlor’s spouse and other dependents. Lastly, a QPRT’s residence can be sold and transferred into a qualified annuity instrument or reinvested into another residence, whereas a PRT prohibits the sale of the residence.
Bonus Concept: There is no tax on estate / gift transfers between spouses, which is why many of the above trusts work.
Andrew M. Lieb, Esq., MPH, is the managing attorney of Lieb at Law P.C. and is a contributing writer for Behind the Hedges. Read his work here.