September 2012 Archives

Asset protection for Bernie (I of ??).

September 27, 2012, by

TE BLOG. Golfers Senior Men. 09.2012. iStock_000009837463XSmall[1].jpgRich uncle Nils has a rich friend Bernie. Second-generation guy from Russia. Very successful real estate developer and builder. Wealthier than Nils, and that's saying something. Also a client of our CPA friend Lars.

Bernie has a longtime wife (Liza), and children and grandchildren, all unlike his newly-wed friend Nils. Now that he is old and rich, Bernie is thinking a lot about protecting what he has, and not so much about making more. His awake-in-the-night thoughts have featured vague possible lawsuits against him. In the light of day, there aren't any particular suits filed or even threatened right now. However, he's seen things like claims of faulty work made against condominium developers. Building and selling condos was one of Bernie's several modes of making money in real estate, a lot of it, and he's not ready to give a bunch of it back to lawyers.

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The unlimited marital deduction and QTIP trusts.

September 20, 2012, by


TE BLOG. Older woman raking leaves front of house. 09.2012.iStock_000014059121XSmall[1].jpgWe have seen that Uncle Nils has agreed to leave his Washington house and a $2 million trust for wife Sylvia if he predeceases her. We have more recently seen that Nils has decided to go beyond the minimum requirements of his premarital agreement, and increase the amount of the trust. This will be treated favorably in Nils's estate, allowing it to deduct the gifts from the gross estate in computing the amount of tax. The later cost of this is that what she inherits from Nils must be included in Sylvia's estate, but her estate is much smaller than Nils's so the tax consequence may be minimal.

The eventual gift of the house to Sylvia (assuming Nils dies before her) will qualify for the marital deduction because it is outright. She will be the new owner of the home, in her own name.

The trust for her may be deducted from Nils's estate only if it meets certain rules known as the "QTIP" requirements set mainly to assure that Sylvia gets significant benefit from the trust. What are these rules and what choices does Nils have in designing the trust for her?

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What's the big deal about family partnerships and family LLCs?

September 13, 2012, by

TE BLOG. Mold Window. 09.2012. iStock_000011944815XSmall[1].jpg
We have seen that Uncle Nils has all his investment real estate in limited liability companies (LLCs). He even has one LLC with just cash, waiting to be invested in the next project. Why do people use LLCs?

One big reason is limiting liability. If Nils owned his properties outright, just in his own name and not in an entity, any lawsuit coming out of one of them could threaten all his holdings. So if there were a disastrous loss in just one real estate venture, say an injury or an economic meltdown, someone might get a huge judgment against Nils as owner, and seize any of his assets, not limited to the project in which the loss was incurred. And there are serious potential liabilities in owning real estate; see for instance some of the mold cases in recent years. If on the other hand the property is in an LLC, only the holdings of the LLC would be at risk. A limited partnership has a similar effect, at least for those who are limited partners rather than general partners. In Nils's state of Washington, limited partnership law has recently been updated to offer the same protection to all partners as the LLC, its newer cousin.

A second reason for LLCs is centralization of management where more than one owner is involved. If Nils owns a property with two or three others, it's important to define who is responsible for overseeing any construction, maintenance, insurance, and other business activity. If three people are just plain co-owners without a partnership or LLC agreement, then management remains undefined. In most of Nils's LLCs, nephew Lars is designated as the Manager and his responsibilities and compensation are described, as is the inability of other owners to interfere with Lars's management. Also important is to name successor Managers, in case something should happen to Lars.

Third, LLCs are convenient arrangements for making gifts. Once he places a property in an LLC, Uncle Nils can, on whatever timetable he chooses, share ownership with other family members. It works much better to give LLC interests than fractional interests in direct real estate ownership, for the reasons given above. With an LLC, the new owners have limited liability, and also limited opportunity to participate in decisions. This wouldn't be the case with shared direct ownership. So Nils can give small LLC interests to greatnieces and greatnephews without jeopardizing nephew Lars's control. And Nils has done that with most of his projects. In reporting the gifts he has followed certain valuation principles that bring us to the big debate, the big deal about family partnerships and family LLCs.

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Taking advantage of the $5 million gift tax exemption (IV of IV): Nils's surprising decision.

September 6, 2012, by

TE BLOG. PLU. Alan permission. 09.2012.YO3R3871.jpg As we learned three weeks ago, our CPA friend Lars has recommended three ways for rich Uncle Nils to take advantage of the $5 million Federal gift tax exemption that might not be available after this year. Nils's home state of Washington doesn't tax gifts at all, so large gifts are particularly useful in reducing that tax.

Lars has suggested a personal residence trust with Nils's California house, a transfer of all Nils's interest in his only underperforming real estate LLC, and some combination of gifts of portions of the two more successfully cash-flowing real estate LLCs.

Nils has been turning these ideas over in his head and has a different notion of what he should do. He's pretty clear on what he will tell Lars when they meet again. First, he does not want to give away his California place. He wants to retain complete control of it because he and Sylvia might possibly make that their primary home some day. They've made good friends down there in the winters and the weather is nice. Another motivation to move there is the Washington estate tax: California has none, at least for now. There's a drawback in that California does have an income tax (Washington does not). It's because of this tradeoff that nephew Lars has half-joked that a rich guy should move south just before he dies.

Nils has taken the suggestion of giving the underperforming LLC and amended it in his head. He wants to merge the cash from his inactive LLC into it, and then give it to relatives. The cash can pay down the debt and so allow the property to produce net cash flow. There is enough cash that the merger will also create a pool for additional investment. So when a good deal comes along, Nils and Lars can take advantage of it in the merged-together entity placed outside Nils's taxable estate. This will use most but not all of Nils's remaining gift tax exemption, but he wants to leave it at that plus a couple other notions he has for saving estate tax.

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