In 2005 every individual has a credit shelter that allows them to leave $1,500,000 of assets at death without incurring federal estate tax. In 2006, the credit shelter amount will increase to $2,000,000. An individual can use up to $1 million of their credit shelter on lifetime gifts without incurring any estate or gift tax.
Whether your goal is transferring property gradually to children, conserving property for future generations or limiting estate and gift taxes, there are several options.
Benefits of creating a LLC
One useful option is to place the property in a limited liability company (LLC). The property owners create an LLC and transfer ownership of the real estate to the company. The owners can then make gifts of membership interests in the company to their children and/or grandchildren.
The senior generation can gift away a majority or all of the membership interest at one time or transfer the interests over a period of years. If the LLC’s operating agreement is carefully drafted, the senior generation can take valuation discounts on the gifts of membership interests.
In other words, if a parent makes a gift of a $15,000 membership interest, the value of the gift for tax purposes may be less, such as $11,000, if the gift is a minority interest in an entity over which the child has limited control. This can reduce the parent’s overall estate and gift tax liability.
One reason LLCs are so effective for passing key real estate to future generations is their flexibility. The senior generation can provide a framework to decide how the family will manage, maintain and use the property for future generations. An LLC operating agreement can direct how the family cares for and uses the property.
The goal is to provide a framework for maintaining and retaining the property, and avoid disagreements and misunderstandings as the number of LLC members expands. The LLC members can always modify or amend the operating agreement to provide for changes in circumstances or for any reason, if the members agree.
In addition, the LLC operating agreement can include restrictions on transfers of membership interests and other provisions to ensure that the property remains in the family for generations and that it does not end up the hands of any member’s creditors (including a divorcing spouse).
Qualified personal residence trusts
A person can use a QPRT to give a personal residence to children or grandchildren but minimize the value of such gift for tax purposes by retaining an interest in the property for a period of years.
The terms could provide that the parent can live in the home for a period of 20 years, and at the end of that term, ownership of the home transfers to the parent’s selected beneficiary. If the parent wishes to continue living in the home, he should now pay rent to the new owner.
At the time the home is placed in the QPRT, the parent is making a taxable gift. However, the value of the gift is calculated by using IRS guidelines to determine the value of a remainder interest in the home after the 20-year period. Thus, the value of the gift (for tax purposes) is reduced by the value of the parent’s retained 20-year interest. In addition, the value does not include the amount by which the home will appreciate during the 20-year term.
Though both options can provide significant tax savings, there are reasons why a QPRT may be more desirable or beneficial than an LLC to some families, and vice versa. Thus, if you are considering either option, you should discuss the costs and benefits of each option in detail with your lawyer.
In addition, you should discuss the ability to retain homestead exemption and avoid uncapping of real estate values (for real estate tax purposes), as well as capital gains tax issues when weighing your options.
Judy Layne is a member in the Dickinson Wright’s Bloomfield Hills office, specializing in estate planning. Reach Layne at (248) 433-7563 or firstname.lastname@example.org.