Estate Planning Advisor Selling Your Residence? Plan to Maximize - - PDF document

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Estate Planning Advisor

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2 Working Backward Still Takes You Forward 3 Is the End of Discounted Family Partnership in Sight? 4 The Basics of Charitable Remainder Trusts Planning to downsize? Helping a parent sell the family homestead? The Internal Revenue Code permits gains from the sale of a principal residence to be realized tax-free, subject to relatively generous limits, as long as certain re- quirements are met. Here are a few pertinent points:

• 1. The Basic Rule

If a couple (or either spouse) owns real property used by the couple as their principal residence for two of the five years ending on the date of sale, $500,000 of the gain on sale ($250,000 for an individual) will be exempt from capital gains taxes. Ownership and use periods need not be concurrent. For example, a couple who rented their resi- dence for two years before buying it and sold it a year later would qualify for the

• exemption. Purchase of a replacement

residence is not necessary in order to qualify for the exclusion.

• 2. The Nursing-Home Exception

Time residing in a licensed care facility is credited toward the two-year residence requirement.

• 3. The Survivorship Exception

Sale of a couple’s residence within the two years following the death of

• ne spouse will qualify for the full

$500,000 exemption, assuming that

• ther requirements are met.
• 4. Trust Ownership Issues

Ownership of the residence by a revocable trust will not affect eligibility for the exemption. But if the grantor of the trust dies and the trust becomes irrevocable, the exemption, including the survivorship exception discussed above, will no longer be available to the extent that the property is owned by the irrevocable trust. This may not make a difference in most circumstances, since the tax basis of the residence would increase to the fair market value at the grantor’s death. But loss of the exemp- tion could result in some taxable gain if, for instance, a sale were delayed so that a surviving spouse could continue to live there, and the property increased in value in the meanwhile. In any event, the possible loss of the exemp- tion should be considered in allocating assets to bypass or credit shelter trusts following the death of one spouse.

• 5. How About the Second Home?

The home that a taxpayer uses as a residence for a majority of the year is normally considered his or her princi- pal residence. But other factors, such as voting registration, driver’s license, motor vehicle registration, and address used for income tax returns, can enter into the determination.

• 6. Is the Lot Next Door Eligible?

The exemption can apply to sales of vacant land adjacent to a residence if the

• wnership requirement is met, the land

was used as part of the residence (e.g., as a playground for the kids), and the land was sold within two years of the sale of the residence.

Selling Your Residence? Plan to Maximize Your

by Jack B. Schwartz

jack.schwartz@millernash.com 503.205.2560

Tax Exemption

Working Backward Still Takes You Forward

Estate Planning Advisor | miller nash graham & dunn llp | 2 Business owners are often caught in a seemingly never-ending cycle of decisions to make and things that need to get done. Jumping onto a rapidly spinning carousel can be daunting, so it is sometimes easier to busy ourselves with other things, off to the side. But planning for the future of your busi- ness and executing those plans is the

• nly way to slow the carousel down

and turn the never-ending circle into a direct path to your goals. If you are uncertain about where to jump in, start at the end—with your estate plan. All business owners need an estate plan. Creating or up- dating your estate plan is a specific project with a beginning and an end. But it will take you one step closer to your successful future. A successful estate plan achieves three important personal goals:

• 1. Financial Security (for the

decedent’s heirs).

• 2. The Right Person. The de-

cedent (rather than the state) chooses who receives his or her estate.

• 3. Estate Tax Minimization. This

reduces the government’s bite, leaving more funds for one’s heirs. Next, a successful business exit plan achieves three important owner goals: 1. Financial Security. The busi- ness sale or transfer provides the amount of income the

• wner, and owner’s family,

needs after the owner’s exit. 2. The Right Person. The owner chooses his or her successor (children, key employees, co-

• wners, or a third party).

3. Income Tax Minimization. This maximizes the amount

• f cash in the departing
• wner’s pocket.

Thinking of exit and estate plan- ning in tandem brings a business

• wner’s entire picture into focus:

For example, when you update your estate plan, you most likely revisit your expectations for your family, during your lifetime and beyond. You will re- view and update the value of your busi- ness to see whether it will support your

• plans. In securing an estimate of value,

you possess a piece of information that is critical to both your estate plan and your ultimate exit plan. Estate planning gives you a valuable perspective on your future. So start at the end and work backward.

• If something happens to you

before your ideal business exit can occur, how will you provide your family with the same income stream that they would have enjoyed if all had gone as planned?

• If you hold on to your business

until well into your golden years, does your current plan take the long-term issues into account? How will you make sure that your business retains and increases its previously determined value?

• If you plan to transition some
• r all of your ownership in

the business to one or more children, does your estate plan adequately address your prefer- ences for the business-active children as well as those who are not involved in the busi- ness, or will they fight it out after you are gone?

• If you die before you exit the

business, are you certain that your family will still receive the full value of the business? (This question is especially important to answer if you are the sole owner. Sole owners are unlikely to have a buy-sell agreement because there are no remaining co-owners to purchase and/or continue the business.) Your estate plan can manage these issues, but does it? It is worth repeating that you must devote the same energy and analysis to lifetime transfers (benefiting you) as you do to a transfer occurring at your death (benefiting your family). Since both planning your exit from your busi- ness and planning your exit from this

by William S. Manne

bill.manne@millernash.com 503.205.2584

“There isn’t one right answer to the ‘estate or exit planning?’

• question. In the end, you must

take action on both fronts, since a failure to act in either creates lasting problems not just for you, but for your business and your family.”

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Estate Planning Advisor | miller nash graham & dunn llp | 3 Family limited partnerships have been a key component of many estate plans throughout the years, but new regulations on the horizon may alter families’ abilities to use these tools to pass wealth to fu- ture generations. The estate planning strategy associated with family limited partnerships in- volves creating an entity—usually a limited partner- ship or, in more recent years, a limited liabil- ity company—and using that entity to hold family assets. Then nonvoting, nonmarketable interests in the entity could be transferred to future generations, ei- ther outright or in trust. This allowed the senior generation to pass wealth to future generations without necessarily passing control. These entities were normally formed with liquidity and marketabil- ity restrictions. Generally, the interest holder could not force the entity to redeem his or her interest and was allowed to transfer the interest only to certain individuals. Because of these restrictions, the values of the interests

• f the entity were discounted to reflect

the fact that the interest holder of a minority interest in a closely held busi- ness does not have the same rights as he or she would have had by holding the business’s assets outright or by holding marketable securities. Discounts often ranged from 30 to 45 percent. The IRS, however, appears poised to release proposed regulations to limit the use of valuation discounts on such transfers. Section 2704 of the Internal Revenue Code governs “ap- plicable restrictions” and also defines restrictions that should be disregarded when valuing a transfer of interests in a family limited partnership. For more than a decade, the IRS has noted that providing new regulations under this Code section is a priority, and based

• n recent comments made by an IRS

spokesperson, it appears that the IRS will issue new regulations soon. While it is impossible to know exactly what any new regulations will provide, most planners anticipate that the proposed regulations will limit a family’s ability to discount the value of family limited partnerships transferred, likely by defining new restrictions that should be disregarded when valuing transferred interests. It is yet unknown when any future proposed regulations may be effective, and whether (and to what extent) previ-

• usly completed transactions will be

“grandfathered.” All that can be said for certain is that if you have con- templated using a family limited part- nership to transfer your family’s wealth to the next genera- tion, you may want to act now before the new regulations are

• fficially proposed.

Is the End of Discounted Family Partnership in Sight?

by Adrienne P. Jeffrey

adrienne.jeffrey@millernash.com 206.777.7512

Estate Planning Advisor | miller nash graham & dunn llp | 3

Estate Planning Advisor | miller nash graham & dunn llp | 4

by A. Paul Firuz

paul.firuz@millernash.com 206.777.7443

The Basics of Charitable Remainder Trusts

Charitable remainder trusts (“CRTs”) are irrevocable, split-interest trusts that are ideal for certain philan- thropic clients, and these trusts are in- creasingly popular now that real estate prices are soaring. This article will be the first in a two-part installment dis- cussing CRTs: this segment will cover general principles applicable to all or most CRTs, and the next segment will review many of the most popular types

• f CRTs, and explore their distinguish-

ing characteristics. What Is a CRT? CRTs are specifically authorized by the Internal Revenue Code, and allow

• ne or more noncharitable

beneficiaries (which may in- clude the grantor) to receive payments for a specified term, and distribute the remaining assets to one or more qualified charitable organizations at the end of the term. In the year the trust is funded, the donor receives a charitable deduction for the present value of the remainder interest that will eventually pass to charity. Common Planning Considerations If a client ultimately intends to sell the asset to be contributed to a CRT (e.g., the client holds appreciated real estate and is ready to sell), transferring the asset to a CRT and then having the trust sell it allows the client to (1) achieve an income tax deduction and (2) defer (or possibly avoid) capital gains tax. The client receives the charitable deduction from ordinary income in the year that the trust is created. Because the capital asset is held by the CRT and not the donor, the CRT (not the donor) will realize the capital gain when the asset is sold. Because the trust itself is tax-exempt, tax on the capital gain realized on the sale of a CRT’s asset is deferred until that income is distrib- uted (see above)—as a consequence, the donor may pay tax on that capital gain in future years. CRTs are obviously most appealing to clients who are already charitably inclined; they involve irrevocable trans- fers of property with only a stream of income coming back to the grantor. These trusts are especially worth con- sidering in high earning years, when the donor holds appreciated property and is motivated to sell, when there is a need or desire to diversify a concen- trated position in the donor’s portfolio,

• r when an IPO or an M&A transaction

is contemplated. Basic Rules A CRT can have a fixed term of up to 20 years, or may be created for the life of one or more individual income beneficiaries, depending on their ages. Any qualified charity may be used as the charitable remainder beneficiary, and the donor may designate one or more charities to receive the remainder

• interest. Additionally, the donor may re-

tain the right to change the designated charitable beneficiary, provided that the new designee is also a qualifying chari- table organization. The value of the remainder interest at the time the CRT is created must be at least 10 percent

• f the initial fair market value of the

property contributed, and the payout to the noncharitable beneficiary must be at least 5 percent. If the trust is created during the do- nor’s life, the donor receives an income tax deduction in the year it is created. If the trust is created at the donor’s death, the donor receives an estate tax deduc- tion that is not subject to any percentage limitations. How Does the Tax Work?

• 1. Taxation of Gift or Bequest

If the grantor is not the beneficiary of the noncharitable interest, the grantor makes a taxable gift (or bequest) of the value of that noncharitable interest in the year the CRT is created.

• 2. Taxation of CRTs

CRTs themselves are not subject to federal or state income tax unless they have unrelated business taxable income. Noncharitable beneficiaries, however, may be subject to income tax on the distributions they receive.

• 3. Taxation of Distributions

The Internal Revenue Code estab- lishes an order for making distribu- tions from a CRT, using four separate categories of income and principal. Estate Planning Advisor | miller nash graham & dunn llp | 4

“CRTs are obviously most appealing to clients who are already charitably inclined; they involve irrevocable transfers of property with only a stream of income coming back to the grantor.”

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Estate Planning Advisor | miller nash llp | 7 Selling Your Residence? Plan to Maximize Your Tax Exemption | Continued from page 1

Think Ahead: Family Fire Drills for Strategically Integrating Contingency Planning

The unexpected happens! Are you ready? Is your business ready? Please join us for this complimentary workshop focused on family fire drills. The workshop is designed to give you an opportunity to enhance the long-term strategic management of your family business and financial assets. The opportunity will be unfolded in a series of fire drills that will encourage you to:

• 1. Establish methods for providing continuity and leadership during unexpected change;
• 2. Develop methods for enhancing individual and family competencies in the areas of financial, human, and social capital

as the foundation for family wealth continuity; and

• 3. Develop foresight and transition planning for controlling risk and decision-making in the family and its operating

companies. The workshop will be beneficial to all family members involved in the current and/or future operations of the business. The evening will include drinks and hors d’oeuvres at the conclusion of the program. The program is not intended for other advisors. Tuesday, September 22, 4:00-6:30 p.m. Miller Nash Graham & Dunn LLP (Portland Office) 111 S.W. Fifth Avenue, Suite 3400 Portland, Oregon 97204 R.S.V.P. to 503.205.2367 or familybusiness@millernash.com. Validated parking will be provided. Estate Planning Advisor | miller nash graham & dunn llp | 5 7. What if I Rent Out the Spare Room Through Airbnb? Use of space in a residence for business or rental purposes can result in partial loss of the exemption. There would be no loss of exemption if (a) the space was not being used for business

• r rental at the time of sale; (b) there

was no business or rental income from the space in the year of sale; and (c) the space was used for the taxpayer’s residential purposes for two of the five years preceding sale. Recapture of de- preciation that you may have previously deducted from income would still be necessary, however, because the exemp- tion applies only to capital gains, not

• rdinary income items.

As these examples demonstrate, application of the exemption is a simple matter in a straightforward situation such as sale of a couple’s long-term

• residence. But other circumstances can

mean that the exemption does not ap- ply, or applies only partially, and require careful consideration when a property used as a residence at any time is sold.

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The Basics of Charitable Remainder Trusts | Continued from page 4 Distributions are taxed first as ordinary income to the extent of the ordinary income from the current year plus undistributed income accumulated from prior years. If the current-year distribution exceeds the current year’s

• rdinary income and all accumulated

but undistributed ordinary income, the excess will be taxed as capital gain, to the extent of the trust’s current-year capital gain and all prior years’ undis- tributed capital gain. Only after all cur- rent and undistributed taxable income is distributed are tax-exempt or tax-free distributions made. Working Backward Still Takes You Forward | Continued from page 2 life are based on the same premises, it can be relatively easy to develop a consistent outcome. There isn’t one right answer to the “estate or exit planning?” question. In the end, you must take action on both fronts, since a failure to act in either creates lasting problems not just for you, but for your business and your

• family. Start with the end (your “end”),

by deciding what role your business will play when you are gone. Then work your way backward to where you are today and how that compares to where you need to be. Then work forward, and your exit plan will start to take shape. A version of this article was previ-

• usly published by Business Enter-

prise Institute in The Exit Planning Review™.