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Estate Planning for Apartment Owners: New Laws Shift Focus to Income and Property Tax Savings – by Kenneth Ziskin, Attorney

Posted on 01. Jul, 2014 by in all, Magazine Articles

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When “The American Taxpayer Relief Act of 2012” (“ATRA”) became effective in 2013, estate planning for most apartment owners turned upside down.

Before ATRA, fear that expanded estate tax exemptions (beginning in 2001) might expire lead many planners to emphasize estate and gift tax planning over income tax planning.  Estate and gift tax savings from keeping assets out of one’s estate dominated other tax issues for many couples that owned apartments. 

ATRA Changed Estate and Income Taxes

ATRA reduced the effective estate and gift tax rate permanently from 55% to 40%, and made permanent an expansion of the exempt amount you could give or leave to your heirs without estate taxes to $5.25 million.

That exempt amount could be doubled ($10.5 million) for a married couple, and the surviving spouse could use “portability” to claim whatever part of the exemption his or her spouse did not use.  And, as a “cherry on the top”, the exemption would grow each year with inflation.  In 2014, the exemption amount grew to $5.34 million, equaling $10.68 million per couple.

Now, apartment owners having a net worth less than the exemption amount usually do not need to worry about estate and gift taxes. But, income taxes inCaliforniahave become far more troubling.  The top combined tax rate (including the ObamaCare tax) on investment income in California now exceeds 50%, and even the “preferred” rate on capital gains on real estate can be as high as 41%!

Estate Plans Done Before 2013 May Be Dangerous to Your Wealth

Many estate plans done before 2013 properly focused on keeping assets out of one’s estate.  For married couples, planning included a “Credit Shelter” or “Decedent’s” trust to use the exemption then available from the death of the first spouse to die, and many types of gift trusts.

After ATRA, keeping assets out of one’s estate, or using the exemptions of a first spouse to die, no longer saves any money for most families, even apartment owners.

Worse, if you have appreciated assets, keeping them out of your estate can cost heirs hundreds of thousands, or even millions, of dollars in income taxes.  Assets outside the estate do not get a new income tax basis (“step-up”) upon death.  Moreover, strategies used to move assets outside the estate (including LLCs) can lead to property tax reassessment costing tens of thousands of dollars per year.  

Danger from “Old” Planning

Mom and Dad had a living trust drafted in 2001.  Dad was suffering a terminal illness. Their old living trust included a house worth about $1 million (tax basis about $250,000) and an apartment building worth about $2 million (tax basis about $180,000, now fully depreciated).  Mom and Dad’s total estate was less than $5 million.  The property tax assessed value of the house and building totaled $600,000. The family wants to keep the apartment building after Mom and Dad die.

Mom and Dad titled the house and apartment building in joint tenancy decades ago.  Later, they contributed the apartment building to an LLC owned by their living trust.

Their living trust provided for dividing the assets into equal parts upon the death of the first spouse, half to a “Survivor’s Trust” and half to a “Decedent’s Trust.”  The Decedent’s Trust would not be included in the survivor’s estate, to take advantage of the first spouse’s estate tax exemption.

This planning had several adverse consequences:

  1. When Dad dies, only half of joint tenancy property gets a “step-up” in basis.  Their CPA estimated that this would reduce the depreciation they could take after Dad’s death by about $22,000 per year, at an estimated income tax cost of about $10,000 per year.
  2. When Mom dies (she has a life expectancy of another 15 years), only her half of the property then gets a “step-up” in basis.  Their CPA estimated this would cost the family another $6,000 per year from lost depreciation.
  3. When Mom dies, the LLC interests left for their children will lead to property tax reassessment.  Mom and Dad estimated this will cost $25,000 per year for 30 years (a total of $750,000!). 

Savings from New Planning

We redraft their living trust to make sure their assets would be used the way they wanted; to convert the interests in the house and apartment building to community property; and to take the apartment building out of the LLC.

The results:

  • Both the apartment building and house will get a full step-up in basis, both when Dad dies, and again when Mom dies.  This should save about $250,000 of income taxes over Mom’s life and upon sale of the house.
  • The step-up in basis at Mom’s death should save $300,000 of income taxes over the life of the children.
  • By taking the property out of the LLC, and restructuring some of the terms of the living trust, the anticipated property tax savings over the children’s lives should exceed $750,000. 

TOTAL ANTICIPATED TAX SAVING:  MORE THAN $1 MILLION!

IF YOU FAIL TO PLAN, PLAN TO FAIL

Every family needs good estate planning.  But now, more than ever, such planning needs attention to preserve and obtain income and property tax benefits.  For most apartment owners, the latter will exceed the estate tax benefits of older plans.

If you drafted your plan before 2013, you should have it reviewed by a competent estate planning attorney that cares about income, estate, gift and property tax consequences.

Kenneth Ziskin, an estate planning attorney, focuses on integrated planning for apartment owners.  He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell.  Ken will host a FREE SEMINAR on “Estate Planning for Apartment Owners” on Tuesday, July 22 from 11:30 AM to 2:30 PM, with a free catered lunch at the Sportsman’s Lodge in Studio City (registration required). To register or for more information call his office at (818) 988-0949 or send an email to ZiskinLaw@gmail.com.   Ken’s website is www.Family-Wealth-Strategies.com  Ken offers free consultations for AOA members. 

This article is general in nature and not intended as advice for clients.  Please get advice from counsel you retain for your own planning.