Top 5 Estate Planning Considerations for the Effective Transfer of Real Estate Ownership

Andrew Lieb
Andrew Lieb

Your Hamptons real estate investment is your legacy. Here are the top five estate planning considerations for keeping your Hamptons property in the family, in order to produce income for generations to come.

Owners with Both Participating and Non-participating Children

Where not all children participate in the management of their parents’ investment real estate portfolio, parents should consider the following three wealth transfer solutions in order to continue their legacy while avoiding friction and potential lawsuits between their heirs.

1. If parents own non-real estate assets that are of equal value to their real estate holdings, the parents should divide their estate so that only the actively participating children receive ownership of the real estate holdings.

2. If parents do not have non-real estate assets that are of equal value to their real estate holdings, the parents should obtain life insurance to provide the inactive children with a fair, but non-business related, share of their parents’ estate.

3. Irrespective of the amount of real estate and non-real estate assets that comprise the estate, parents can alternatively divide their real estate holdings into managing and non-managing membership interests. In such, parents can provide their participating children with control and their non-participating children with financial security.

4. Under this solution, the Membership Agreement should provide a forced sale/buyout option, with a predetermined formula to set terms, for the non-voting members to exit the business if such non-voting members believe that they are being locked out of distributions by the voting members. As a result, the voting members will be motivated to deal fairly with their non-voting siblings.

Strategic Gifting

In order to minimize estate and gift taxes (the federal government taxes estates valued over $5.49 million dollars at a rate that can reach up to 40% and, after April 1, 2017, New York State taxes estates valued over $5.25 million at rates that can reach up to 16%), parents should utilize strategic gifting, which freezes the valuation of the corpus for tax purposes at the then fair market value, rather than allowing such corpus to appreciate throughout the years until the date of death. When strategically gifting portions of a real estate portfolio between family members, it is imperative that:

1. The gifted real estate is properly valued by a licensed or certified appraiser; and

2. A gift tax return is promptly filed with the IRS.

Failure to properly value may result in the imposition of significant late fees, interest and other penalties, should the IRS later challenge the valuation and determine that additional taxes were owed (the annual gift tax exclusion remains $14,000 for 2017, but the entire federal estate tax exclusion, the $5.49 million, can also be utilized for gift tax purposes instead of estate taxes should parents wish to avoid gift tax; also, New York State does not have a gift tax). Further, prompt filing of a gift tax return is imperative in order to accrue (begin to run) the 6-year statute of limitations for the IRS to challenge the valuation.

Proper Vessel

Parents’ selection of the proper vessel to transfer their investment real estate requires their consideration of the following factors, including the degree of control, amount of acceptable administrative efforts/costs and amount of income necessitated coupled with the corresponding tax implications resulting therefrom. Some of the most commonly utilized options are:

1. Straight Gift. While it is the simplest and least expensive transfer vessel to effectuate, it results in a complete loss of control and income over the property while creating an immediate corresponding capital gains tax event.

2. Intentionally Defective Grantor Trust. Such a trust allows parents to reduce their taxable estate, while also permitting the availability of future controls by allowing the parents to reacquire the property of the trust at a later time. Additionally, the taxable estate can be further reduced by parents paying the IDGT’s income taxes.

3. Grantor Retained Annuity Trust. This vessel reduces parents’ taxable estate while providing such parents with a fixed payment of future monies for a defined period of time to fund their lives.

4. Qualified Personal Residence Trust. An appropriate vessel where the real estate is a second residence (e.g. summer home). By transferring the residence into this trust, the future appreciation of the property freezes its fair market value at its then fair market value for tax purposes, and the parents can nonetheless continue to use the real estate for the remainder of their lives.

5. Spendthrift Trust. The perfect vessel when transferring real estate to someone who cannot control their spending. This trust protects the real estate from the beneficiaries’ creditors, but permits the beneficiaries (and unfortunately their creditors) access to income.

Preserving Step-up-in-Basis

In order to preserve the step-up-in-basis (i.e., avoidance of capital gains tax), which is available only where an investment is held until the purchasers’ demise, the provisions of any trust funded by the strategic gifting of interests in real estate must include a power of appointment. As to savings, New Yorkers who do not benefit from a step-up-in-basis can experience a capital gains tax rate of up to 31.5% when combined with the federal capital gains tax. However, a properly drafted power of appointment will allow the trustee, often the children, to decide at a later time whether to keep the assets in the trust, thereby minimizing the taxable estate, or to elect to have the assets counted in the taxable estate and preserve the step-up in basis. The availability to have this decision-making option closer to the date of demise is necessitated because future predictions are often terrible concerning the future valuation of overall estate assets, future estate tax exemptions, overall estate tax law/regulation and future capital gains tax exposure. Yet, one cannot wait until the eve of death to employ their transfer vessel. Instead, it must be done as soon as possible with the option to modify it as facts change.

Medicaid Considerations

When an owner of a portfolio of real estate is interested in protecting their portfolio from the costs of long-term healthcare (care cost over $12,000 per month in 2017), parents should consider the following:

1. Obtaining long-term care insurance.

2. Timing the transfer, whether by a straight gift or a gift to the parents’ trust, because there is a five-year look-back on transfers from the date of an application for Medicaid.

3. If transferring to a trust, ensure that there is absolutely no reasonable circumstance by which the parent, who needs long-term care, can regain control over the gifted real estate.

4. To hedge against the risk that the parent needs long-term healthcare within the five-year look-back period, but no longer has adequate assets to pay for such care, due to the transfer of assets, a Medicaid trust should include a power of appointment, which will allow the parent to functionally revoke an irrevocable trust by way of permitting the parent to change the trustee and/or beneficiaries in the event that such party will not consent to a revocation of the trust.

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 more real estate law articles by Andrew Lieb, Esq., MPH

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