Real estate professionals may find it hard to cede control of their assets through estate planning. High-net-worth individuals, who benefit most, are also often most resistant to shifting control of their fortunes, carefully accumulated and maintained over a lifetime.
Anticipating the possible economic and family scenarios and shifting control can be difficult, but swift action is necessary, especially for individuals who want to engage a trustee to make prudent decisions regarding the investments.
The higher the net worth, the more benefits a good plan may accrue to future generations when grantors prepare well in advance and review frequently. Larger clients also require more intricate, sophisticated plans, demanding more foresight and time. What does estate planning entail and what are some considerations for those with a real estate-heavy portfolio? We caught up with Berdon LLP tax principal Victoria Abramov, who has 25 years of experience advising firms and families, to find out.
What Is An Estate Plan And Who Needs One?
A solid estate plan represents a complete and efficient vehicle to pass assets down to the next generation. Taxes are a chief consideration, but plans also encompass business succession planning, detailing the capacity different children will have in the business and how they will get compensated. Plans’ functions include creditor sheltering, protecting children from predatory family members (or their own potentially prodigal spending), and ensuring disabled relatives are provided for once a matriarch or patriarch passes on.
“Real estate often involves a lot of assets with negative capital accounts from cash pulled out through refinancings, and when liability exceeds tax basis of the real estate, it could trigger gain on transfer or disposition to family members,” Abramov said.
If, for example, someone transfers to a trust properties worth $1M, having a total basis of $200k and a mortgage of $300k, he will be subject to tax on the $100k that represents the difference between the liability and total adjusted basis.
This is taxed at the capital gains rate. Those with highly levered, debt-heavy portfolios must be cognizant to avoid incurring a large current income tax burden. They should also know that things like depreciation, capital improvements and loans can augment or diminish the tax basis.
If the asset is held on to, then the income tax may be totally avoided — the tax code currently stipulates that when a person dies, the assets included in their estate be stepped up to fair market value.
What Imminent Legislation Will Alter Tax Policy and Considerations?
One trending topic is abolishment of the “death tax”; however, “the gift tax is still in play, and as planners we have to go with what we know now while keeping an eye on the impact of possible changes,” Abramov said. If President Trump succeeds in eliminating this “death tax” it would benefit the 1% of individuals, who, at death, have over $5.45M (or $10.9M for couples) to bequeath.
Abramov told us that getting rid of step-up basis and carryover, which Trump proposed as compensatory measures on the campaign trail, could be detrimental to the wealthy. If the basis step-up is eliminated and carryover basis is enacted, beneficiaries with appreciated property would pay income tax on the gains upon disposition, requiring them to find out the tax basis of assets bought by the decedent, which is not always easy.
“We’re also mindful of something like a 'sunset' we observed with President Bush, in which reform happened in 2010 and repeal in 2011,” Abramov said.
The U.S. may emulate the system in Canada, under which the estate tax was repealed and whatever assets passed to heirs are treated as sold on date of death. This could be more expensive to real estate investors whose tax on the built-in gain may exceed the current estate tax on the fair market value of the property. It is unclear whether the “sales price” would include the same minority interest discounts currently available.
“We must also keep in mind that this repeal would be federal — and many states still have their own inheritance tax regimes,” Abramov said.
What Are The Most Common Planning Misconceptions And Mistakes People Make?
Abramov said the most common error people make is failing to plan with adequate time. Waiting until the client is older reduces the efficacy and availability of different techniques, and also makes using life insurance as part of the plan a lot more expensive. Abramov said she is able to work most effectively when clients come to her with ample time and their health intact.
Abramov also said that she has seen many clients fail to comprehend just how “irrevocable” irrevocable trusts are. These trusts remove all ownership rights from the grantor, so Abramov tries to ensure her clients are aware of the implications before committing their assets.
“There are mitigating factors we can implement to let people get money out of the assets they are transferring, and in some cases we can provide limited cash flow,” Abramov said. Such precautions include making a spouse a beneficiary, when appropriate, and creating two classes — preferred interest and common interest — thereby freezing the value of the asset and transferring appreciation to the next generation.
How Often Should People Review Their Estate Plans?
“We recommend review every two years, as many potential problems are avoided with proactive thinking,” Abramov said.
Milestones in life, like getting married and having children, may necessitate a fresh review, as do things like illness and tax reform.
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