Estate tax planning can include transferring assets to other family members to reduce the size of your estate.  There are different ways of transferring assets, but most of them include the concept of "discounting" the value of the assets being transferred.  In this issue, we will discuss this concept and show you how now may be the perfect time to take advantage of discounting. 
 
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        As always, please call us with your questions and remember, "Plan Early, Plan Well".

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Doron

Discounting and Transferring Assets to Your Family
 

          When you die, an estate tax may be owed based on your net worth in excess of the amount you can leave estate tax free at death, which is currently $3.5 Million.  If your net estate is $5 Million, there will be, in general, an estate tax on the excess $1.5 Million.
 
        If you transfer assets to your family, the future appreciation in those assets should not be subject to estate taxes when you die.  For example, if you own real estate that has a value of $100,000 and you expect its value to grow to $550,000 by the time you die, and you properly transfer the real estate to your family, the $450,000 increase in value should not be subject to estate taxes when you die.
 
         When looking at how much you are worth, for estate tax purposes, you need to include not just your real estate holdings, businesses, bank accounts, brokerage accounts and similar assets, but you also have to include retirement accounts, IRAs and life insurance on your life that your own or control.  By adding the value of these assets, you are probably worth more than you think for estate tax purposes.
 
          It is important to understand that you should not transfer assets to family unless you are certain you will not need those assets in the future.  If you think you may need the asset being transferred in order to provide income to you at a later date, you may not want to give up ownership in that asset.
 
            If you do want to transfer something, e.g., real estate, to your family, it is important to understand how discounting works.  Let's assume you own a piece of real estate worth $600,000 and you want to transfer it to your son.  If you transfer the entire real estate at one time, you will have made a gift to your son of $600,000 (ignoring for the moment the $13,000 you can give your son each year without reporting the gift).  This gift will reduce the amount you can leave your family estate tax free when you die from $3.5 Million to $2.9 Million because the amount you gifted to your son reduces what you can leave estate tax free when you die.
 
The Concept of "Discounting"

       The concept of "discounting" allows you to artificially reduce the value of the gift so that for tax purposes you have given away less value and thereby have retained more that can be left estate tax free when you die.
 
        Discounting is based on certain factors related to the asset being gifted.  For example, if you transfer 100% of the real estate to your son, he has full control over selling that property, and he has full control over management of the property. 
 
        If on the other hand, you only transfer 40% of the property to your son, his interest in the property is not easily marketable because very few people would be willing to buy a 40% interest in real estate.  In addition, owning 40% does not give him full control over the property because you continue to own 60% of the property.  Each of these factors should result in a discount in the value of the portion of the real estate being transferred to your son. 
 
        If the value of 100% of the property is $600,000, the value of the 40% you transfer would be $240,000.  However, if the lack of marketability and lack of control factors result in a 25% discount in the value of the interest you are transferring, the value of the 40% interest would be $180,000 (i.e., $240,000 less the 25% discount of $60,000) for tax purposes.  In effect, this results in your transferring $60,000 of value in the real estate without any tax effect and leaves you more to transfer at death because you haven't used up as much of your $3.5 Million as you would have if you had not taken a discount.
 
        In order to take advantage of greater discounts, we will sometimes set up a limited liability company or a limited partnership and transfer the real estate into the entity.  You would then gift an interest in the entity to your son (rather than a direct interest in the property), which would result in an even greater discount in value because discounts are greater when transferring a non-managing interest in an entity.

If the Discount Is Not Properly Done, the IRS Will Disallow It

        Discounts are a wonderful tool to use in transferring assets to family members and should be considered in every taxable estate.  However, you must be careful in how the transaction is set up and the type of discount you get.  If the transaction is not property structured and maintained, or the discount is not properly done, the IRS will disallow the discount, which can cause unexpected and unwanted tax consequences.
 
        One further note about discounting is that there is at least one proposal in Congress at this time which would, in general, disallow discounting on transfers of assets between family members.  If this becomes law, the ability to discount the value of assets would no longer be available.  Therefore, if you are thinking of gifting assets and taking discounts, and you are concerned that the proposal disallowing discounts may become law, you should look into making the gift as soon as possible.
 
        Please let us know if you would like to discuss this matter and how it relates to your estate plan.

This communication published by the Law Office of Doron M. Tisser is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation.

Copyright © Doron M. Tisser, Esq. 2009.  All Rights Reserved.