final - succession planning - 2014 aicpa real estate conference (4)

#AICPAreal

Succession Planning:How Real Estate Dynasties Pass the Torch

Anita Hamilton, CPA

American Institute of CPAs #AICPAreal

Anita HamiltonCPAPartnerHORNE LLP26 Security DriveJackson, TN 38305Main: 731.668.7070Direct: [email protected]

Anita Hamilton, CPA Anita is a tax partner in the Jackson, TN, office. She primarily provides services in federal and state tax compliance for individuals, partnerships, corporations, estates and trusts, non-profit entities and bankruptcy work. Anita works closely with clients who need multi-state taxation assistance. She assists closely-held businesses and individuals with complex areas of tax law including entity structuring and resolving difficult tax controversies with state and federal agencies. Anita provides comprehensive tax and other personal financial consulting services to high net worth individuals and family groups and also provides retirement planning consulting services. She provides guidance in estate planning and has several years of experience with inheritance tax returns. Anita has more than 25 years of public accounting experience including real estate tax law, tax ramifications and estate planning and guidance in compliance with government filings. Anita earned a Bachelor of Business Administration from Union University. Professional Affiliations

American Institute of Certified Public Accountants, Real Estate Tax Conference Committee

Tennessee Society of Certified Public Accountants, Board Member Tennessee Society of Certified Public Accountants, State Taxation Committee

Community Involvement

Union University, Board of Regents Exchange Club - Carl Perkins Center for Prevention of Child Abuse, Board Member Jackson Exchange Club, Exchangite of the Year University School of Jackson – Finance Committee and Past Chairman of the Board Jackson Symphony – Finance Chair and Board Member


Outline

I. Transfer Wealth to the Next Generation

II. Change of Leadership

III. Planning Tips• Intentionally Defective Grantor Trust• Dynasty Trust• Current Law


Transfer Wealth to the Next Generation


Change of Leadership


Planning Tips


Intentionally Defective Grantor Trust


Intentionally Defective Grantor Trusts

• Grantor owner of trust for Federal Income tax purposes

• Complete gift to the child


Intentionally Defective Trust

How Do They Work?• The trust assets and the appreciation of the trust assets are

removed from grantor’s gross estate.• Powers commonly used to create an Intentionally Defective

Grantor Trust.- Reacquire trust property by substituting other property of

equivalent value (IRC Sec. 675((4)(c))). The most commonly included power in a trust instrument to create an intentionally defective grantor trust.

- Power to distribute income on principal among beneficiaries- Power to add beneficiaries to trust- Power to use trust income to pay life insurance premiums


Example:Intentionally Defective Grantor Trust

Assume the following facts:

John is the manager and owns 95 percent of the membership interests of Real Estate Now, LLC, which owns several properties as single-member LLCs. The other 5 percent of Real Estate Now, LLC is owned by Sue, a key employee who was provided her ownership interest several years ago. John would like to transfer ownership of the business to his children, Jacob and Katie, and to their descendants on a tax-advantageous basis without paying any gift tax, but, at the same time, he would like to retain control of the business. Assume the cash flow and income have been relatively consistent over the past several years, averaging approximately $450,000 per year. On that basis, an appraiser has valued Real Estate Now, LLC at $3,000,000; however, its value is $1,800,000 on a non-control basis.


One alternative for John is to create an IDGT to which he would “sell” a 95 percent non-managing interest for its fair market value of $1,710,000 (95 percent of the appraised value on a non-control basis), while remaining the non-owner manager of the LLC. The purchase price would be paid by delivery of the trust’s promissory note for the purchase price, which would bear interest at the AFR. The note would be secured by the transferred membership interest, as well as by $171,000 of trust assets, which the trust would obtain via a gift from John (using a portion of his applicable exclusion amount). Note that it is common for the IDGT to be a generation-skipping trust and for the grantor to utilize his generation-skipping tax exclusion against the gift made to the IDGT.



The trust would be an irrevocable trust and would be structured in a manner such that the trust is effective for estate and gift tax purposes (i.e., property transferred to it will not be included in John’s estate). The gift of $171,000 to the trust is designed to provide the trust with economic substance other than the LLC interest that the IDGT will acquire.



From an income tax standpoint, the trust is structured to be “defective”, so that the grantor, i.e. John, is considered to be the owner of the trust for income tax purposes. The sale of property by a grantor to one’s grantor trust is considered a sale to one’s self, so that the sale is not a taxable event.



Let’s take a look at why IDGT planning has become a popular succession planning tool. First, John has “sold” property with a value of $2,850,000 (95 percent of $3,000,000) for $1,710,000. Of course, because the sale is non-taxable there is no step-up in the basis of the property, as there would be if John held the transferred property at the time of his death. However, John has secured a discount that might not otherwise be available, if he held control of the LLC at the time of his death. Second, all the growth with respect to the transferred assets has been removed from John’s estate. Third, assuming the trust qualifies as a grantor trust, John will be subject to tax on the income of the trust used to amortize the promissory note.



The IRS has finally put this issue to bed in Rev. Rul. 2004-64, wherein the IRS publicly ruled that in the case of a grantor trust –

1) The payment of income tax by the grantor attributable to the inclusion of the trust’s income in the grantor’s taxable income is not a gift. This rule is finally an acknowledgement by the IRS that there cannot be a gift when one is paying one’s own tax liability that is imposed by statute (i.e., under the grantor trust rules of Code Secs. 671-679).

2) The right of the grantor to a mandatory tax distribution will cause inclusion of the trust’s assets in the grantor’s estate pursuant to Code Sec. 2036(a)(1), because the grantor has retained beneficial enjoyment of income from trust property. According to the IRS, the amount includible in the grantor’s estate is the “full value” of the trust’s assets, not just the amount necessary to fund the tax distribution.

3) The right of the grantor to a discretionary tax distribution generally is not an estate-includible right, such as in a situation where there is an independent trustee who reviews the need of the grantor for a tax distribution. However, the IRS cautioned that such non-includibility was not a per se rule, and there could be estate tax includibility where the grantor effectively controls whether or not she receives a tax distribution.


Dynasty Trust


• A long-term trust created to benefit descendants of multiple generations.

• Efficient and impactful when funded with highly appreciating assets.

• GST Exemption and Tax

- Grantor allocates their generation skipping transfer tax exemption to a trust with an unlimited duration.

- Trust assets are not subject to wealth transfer taxes.- Irrevocable trust- Domicile the trust in a state with preferable tax and asset protection

laws.- Review any extended rule against perpetuities that may pierce

trust.- Often structured as a grantor trust for income tax purposes.

Dynasty Trust


Dynasty TrustHow does it work?

Let’s say “Tom” has expressed an interest in establishing a trust that would let him benefit his family for multiple generations. With the assistance of Tom’s estate planning attorney, a multigenerational Dynasty Trust is created, and he gifts money each year to the trust in the amount that would cover the life insurance that the trust intends to purchase. The attorney instructs Tom regarding some of the technical requirements in making the gift to ensure Tom leverages his GST exemption.

The trustee of the Dynasty Trust purchases and owns the life insurance on Tom’s life and makes the premium payments. Then, Tom, with the help of his tax adviser, notifies the IRS that he’s used some of his GST tax exemption to shield the Dynasty Trust from the GST tax.

Example:


Upon Tom’s death, the insurance proceeds with be paid to the Dynasty Trust. The trust assets can continue to be held in trust for the benefit of multiple generations of Tom’s family. The assets continue to grow but the trustee has the ability to make distributions to family members as the trust’s beneficiaries. This can continue in perpetuity.

In this example, the Dynasty Trust is created during Tom’s lifetime. It‘s funded with cash to let the trust purchase life insurance on Tom’s life. Tom’s wife could have joined him in his arrangement and the trustee could have purchased survivorship life insurance on their joint lives. Tom could also have gifted other assets, such as securities, that he believes will continue to grow in value. In addition, Tom could have opted to have this trust created at his death, funded with assets held in his estate.

Dynasty Trust


Dynasty Trust can benefit all sorts of families, not just the wealthy, particularly if their goals include:

• A desire to provide for multiple generations of family members;

• An interest in protecting accumulated assets from estate and generation skipping transfer taxes;

• A concern about protecting accumulated wealth from creditors and ex-spouses; and

• A desire to ensure the transfer of family values to successive generations in the form of incentive provisions.

Dynasty Trust


Current Law


Current Law - 2014

Gift Estate GST

Annual Exclusion $14,000 N/A $14,000Lifetime Exemption 5.34 million 5.34 million 5.34 million

Tax Rate 40% 40% 40%

Basis Carryover DOD FMV N/A

Portability Yes Yes No


What happens if you do not plan for future generations?

final - succession planning - 2014 aicpa real estate conference (4)

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