Newsletter May/June 2011

June 13, 2011

In this issue: Planning for Lifetime Transfers in 2011 And 2012; Protection of Real Estate in a Decedent's Estate; Estate Tax Planning with Qualified Personal Residence Trusts

PLANNING FOR LIFETIME TRANSFERS IN 2011 AND 2012

If any of your clients are considering making substantial gifts to their families, this may be the right time to encourage them to make those transfers.

In 2011 and 2012, the lifetime gift tax exemption is $5,000,000 per person, which means that an individual client can gift up to $5,000,000 to their families without incurring any gift tax liability for those transfers.

This may very well be a limited window of opportunity, though; under current law, the exemption is scheduled to be reduced to $1,000,000 on January 1, 2013 (although there is already some speculation that this current law will be amended prior to that date to set the estate and gift tax exemption amounts around $3,500,000 as of January 1, 2013). In either event, however, it appears that this opportunity to make such a substantial lifetime transfer of wealth without gift tax liability will only be available to clients this year and next.

So aside from personal motives, why should your clients consider making substantial gifts during their lifetimes? The most obvious answer to that question is that making such a transfer will likely serve to reduce (or even eliminate) federal estate taxes that may be due upon their deaths. For example, if a client gifted $5,000,000 to their family in 2011 and then died 10 years later, the value of his/her taxable estate would be reduced by $5,000,000 plus all of the earnings and growth on that amount for that 10-year period earned on the $5,000,000 from the time the transfer is made until your client’s death. Assuming a conservative growth rate of 5% on that amount, this $5,000,000 lifetime transfer would remove an additional $3,000,000+ from the client’s taxable estate, thereby generating an additional estate tax savings of $1,050,000 (assuming a 35% estate tax rate) upon the client’s death.

Of course, when a client is planning to make such a substantial transfer of wealth to family members, special care and attention must be given to exactly how those gifts should be made. In our experience, it will be most beneficial to the client (and his/her family) to make the gifts not directly to the intended individual recipients, but rather to an irrevocable trust arrangement – an arrangement that we refer to as a “Family Gift Trust” – for the benefit of the intended gift recipients. Structuring the client’s lifetime transfers in such a manner will allow the client to maintain some control over the gifted assets (e.g., how those assets are to be invested and spent) and, perhaps most importantly, will provide asset protection to the individual gift recipients.

PROTECTION OF REAL ESTATE IN A DECEDENT’S ESTATE

Current real estate market conditions require a heightened level of consideration when administering a decedent’s estate.

The maintenance and safeguarding of real estate – typically the principal residence – in a decedent’s estate or trust is as important now as ever. Often the decedent’s Last Will and Testament or trust provides that the house should be sold and the proceeds distributed to the beneficiaries. Recently, however, real estate has not been selling because of the economy and the difficulties that prospective purchasers have in acquiring financing.

These factors have made it more important for the fiduciary involved (the Executor if the house is in the estate or the Trustee if the house is in a trust) to take a number of measures and precautions to maintain and protect the real estate until a buyer can be found:

• First, the locks on the house should be changed as soon as possible and the keys should be only given to a limited number of trusted persons.
• Second, if any construction or preparations are done to prepare the house for sale, workers or contractors should only be granted access to the property under supervision, and should not be given keys to the house.
• Third, damage and liability insurance should be maintained on the house even if the home is left vacant.

With regard to this last item, while the cost of insurance may increase significantly for coverage on an unoccupied house, if there is a major fire or casualty damage (wind, hail, flood, etc.,) and there in no insurance in place, the fiduciary may be held personally responsible to the estate or trust beneficiaries for breach of fiduciary duty and may have personal liability for the damage. The insurance obtained by the fiduciary should also include liability coverage to protect him/herself and the estate or trust in the event that a contractor or invitee is injured while on the premises.

If a client has difficulties in finding an insurance agent who can provide insurance on a vacant house, there are insurance agents to whom we can refer them.

ESTATE TAX PLANNING WITH QUALIFIED PERSONAL RESIDENCE TRUSTS

QPRTs allow clients to reduce estate taxes on their homes while still living in them.

In light of the widespread depression in property values caused by the recent downturn in the real estate market, planning with Qualified Personal Residence Trusts (“QPRTs”) has attracted a renewed interest among professional advisors and their clients as an effective estate tax planning tool.

In a QPRT arrangement, the property owner transfers his/her primary residence or a vacation home to an irrevocable trust (the QPRT) for the benefit of his/her family, but reserves the right to occupy the residence for a specified number of years.

The transfer of the property to the QPRT is treated as a gift from the property owner to his/her family members (the QPRT beneficiaries) for tax purposes. The owner’s retention of the right to use that property, however, allows him/her to discount the fair market value of the property for gift tax purposes by an amount equal to the value of that retained interest (as calculated using the property owner’s age and the federal Section 7520 rate for the month in which the property was transferred).

For example, assume that a 70 year old property owner transfers a vacation home valued at $2,000,000 to a QPRT with a 10-year term. Assuming that the Section 7520 rate for the month in which the transfer occurs is 2.4%, the value of the property can be discounted by $1,071,980 (the value of the owner’s 10-year retained interest) for gift tax purposes. Assuming further that the property owner does not want to pay any tax on the discounted value of this gift, the property owner could elect to use $928,020 ($2,000,000 – $1,071,980) of his gift tax exemption to offset that tax cost.

If the value of the vacation home appreciates during the QPRT’s 10-year term, our property owner will have made even more efficient use of that exemption amount: Assuming a growth rate of 4% during the 10-year term, the property owner will effectively “spend” $928,020 of gift tax exemption to remove a $2,960,489 asset from his taxable estate.

The estate tax savings in a QPRT arrangement can be calculated by multiplying the difference between the value of the property at the end of the trust term and the gift tax value of the property by the applicable estate tax rate. Assuming a 35% tax rate, the estate tax savings in our earlier example would have been more than $700,000.

There are additional tax planning opportunities available to our property owner if he wants to continue using the residence after his retained interest period ends. We will explore those opportunities more fully in a later edition of this Newsletter.