My wife, Hinda, who helps me with planning for clients, and I have been lucky enough to meet hundreds of wonderful apartment owners though the AOA seminars we have done throughout California. The majority of them planned ahead years ago and built living trust based estate plans to protect their families.
Unfortunately, almost all the plans we reviewed (some just a few years old, and some decades old) have now become “HAZARDOUS TO FAMILY WEALTH.”
Many of these “hazards” result from changes in the tax environment which were not anticipated when plans were originally drafted. Others result from changes in the family. Many others just reflect the growth in family wealth, which is a “good problem” to have. And, a few of the “hazards” are the result of “one size fits all” drafting which, without customized planning, rarely optimizes for “your” goals and unique situation.
The vast majority of our apartment owner clients had a net worth of only a few hundred thousand dollars when they started out. So, it was hard for them to justify the cost of doing good planning and their main goal was probate avoidance. However, today, the vast majority have built multi-million dollar portfolios, which DO justify the cost of careful, customized planning
Changes in the Tax Environment
Most of the old (and, sometimes, not so old) plans we review for apartment owners focused on avoiding probate and making sure that estate tax exemptions were optimized.
But, major changes in estate/death taxes, income taxes and the effect of property taxes have now made it more important for most owners to focus on the income and property tax consequences of their estate plans.
First, the lifetime exemption (now an exclusion) from estate and gift taxes grew from $600,000 in 1997 to $5.45 MILLION in 2016! That means a married couple can now pass nearly $11 million to their heirs free of estate taxes.
Second, the estate and gift tax rate on wealth over the exemption actually fell from 55% to 40%.
Third, one spouse was finally allowed to leave his or her exemption to the other spouse (we call this “Portability”).
Fourth, the top Federal income tax rates rose from 35% in 2003 to 43.4% in Obama’s second term (including the “Net Investment Income Tax”).
Fifth, adding insult to injury, California increased its top rate from 9.3% to 12.3%.
Sixth, while property tax exemptions under Prop 13 did not change much, massive inflation in income property values made it important to preserve and maximize your ability to prevent reassessment when you die.
Combining all of these factors meant that most apartment owners, even after inflation, no longer needed to worry about estate and gift taxes. Those who did need to worry (we think this is about 25-30% of our owner clients) faced less estate and gift tax exposure, both due to the increased exclusion from tax, and the reduced rates.
Changes in the Family
Many old plans were written when owners’ children were still in school, or had not yet built their own families. So, they gave little thought to how wealth should be left to maximize benefits for adult children and for grandchildren. Rarely was any effort made to protect the inheritance for generations from creditors and predators (i.e., potential ex-spouses!).
Changes in Wealth
Very few old estate plans anticipated leaving as much wealth as our clients now expect to have. In many cases, the amount of wealth could now, if not properly handled, change the life of heirs in a negative way, destroying incentives and motivations for heirs.
Lack of Customized Planning
Good estate plans need to be customized to meet your goals. That requires your estate planning lawyer to help you understand your planning options, tease out your goals and desires, help you make important planning decisions and then take the time to draft customized documents to get results you want for your family.
Very few lawyers have the experience to do this while focusing on the special needs of California apartment owners. Furthermore, even those who have the experience often price their services at a level that discourages them from spending the time with clients that is needed to do really good planning and draft custom documents.
However, given the larger estates that apartment owners now have or expect to have at life expectancy, good planning is now much more important than ever before. Now, with larger estate sizes, the benefits of good planning more than justify the cost.
Most Common “Hazards”
While we do see some well written trusts, most of the time we see some combination of the following hazardous features (as well as others which appear less often) in trusts and related estate plans that we review.
- Trusts for married couples that mandate funding of a credit shelter, bypass, exemption or “B” trust. This then prevents getting a second increase in income tax basis when the surviving spouse passes, and can cost millions in unnecessary capital gains taxes for your heirs. With “portability” of your estate tax exclusion between spouses, this “old style” planning is no longer necessary to save estate taxes for most couples.
- Failure to properly document that jointly owned property, (even in the trust) as community property so that both halves get a new, higher income tax basis when either spouse dies.
- Failure to structure the trust so that the property tax exemption of the first spouse to die can be passed to children after the second spouse’s death.
- Failure to structure property ownership in the trust to avoid reassessment even when the first spouse dies.
- Failure to protect assets left for a surviving spouse from creditors.
- Failure to protect the surviving spouse from undue influence that can redirect property away from your natural heirs.
- Use of LLCs or partnerships to hold buildings in ways that cause unnecessary increases in property taxes on the first or second death.
- Failure to provide enough flexibility in your trust regarding allocations of income and principal which can, in turn, lead to higher income taxes after your demise.
Sound Estate Planning Is Also About Opportunities to Better Benefit Your Heirs
We get great pleasure when we can help clients articulate not just what they will leave to heirs, but how they will leave it in order to enhance the lives of their heirs.
In some cases, that means combining protection from creditors and predators, with provisions that will prevent heirs from misusing their inheritance before they develop enough maturity to manage it themselves. None of our clients want their children or grandchildren to be “spoiled” by their inheritance, or to dissipate a substantial inheritance early in life and wind up impoverished in later years.
This almost always requires a lot of discussion with property owners about their goals and family. Then, we teach them about some of the ways they can fulfill such goals. Finally, we spend significant time doing custom drafting to reflect the decisions the owners made. And, we follow that up with explanations of the drafting to make sure it reflects the owners’ desires.
Sometimes this includes provisions to encourage or mandate keeping some or all of the family real estate business together, either for a period of time or permanently.
It can also include provisions that help pass values about hard work, accomplishment, thrift or even community service to your heirs.
The fact is, the opportunities to benefit your heirs, protect them and pass values are only limited by your imagination. We get great satisfaction from educating our owner clients about strategies that have worked for other clients (or not worked) in order to help them think about their planning choices
Opportunities to Enhance Benefits During Your Life
Although most estate planning revolves around benefits for your heirs, it also provides strategies to help you live a better life yourself.
This can include strategies to enable you to sell property without paying capital gains taxes.
One of those strategies is the Capital Gains Bypass Trust (“CGBT”). We wrote about CGBTs in the July, 2016 issue.
For most owners, with properties valued at currently low cap rates, a CGBT can avoid current taxes on the sale of appreciated buildings (some of which can otherwise face income taxes of nearly 40%). If can also substantially INCREASE currently spendable cash flow, obtain income tax deductions that can offset gains or income from other properties and give substantial financial and non-financial benefits to your heirs.
Just as important to many clients, the CGBT can enable them to get rid of the burdens of property management.
The upcoming seminar in Torrance will explore the CGBT strategy in greater detail, and include new material on how to use it even for properties that are encumbered with debt. The seminar will include case studies to help pique your interest and understanding.
Make Your Estate Plan Work Well for Your Family
Making your estate plan work well begins with understanding the planning you have and your planning opportunities. Generally, this should begin with having an experienced estate planning attorney who understands, and works regularly with, the problems and opportunities of apartment owners.
But the real key is good planning. That is why my motto is: “IF YOU FAIL TO PLAN (WELL), PLAN TO FAIL”
The tax environment, your wealth, and your family have probably changed a great deal since you completed your planning. The odds are high that your existing plan does not reflect your current goals for your wealth, nor does it avoid tax risks that changes in the law and your situation have produced.
In order to prevent your estate plan from being a HAZARD to you and your family, get your estate planning reviewed now by a lawyer who will help you articulate your goals, and then put your goals first in any planning you want done. You will get peace of mind, and your heirs will gain substantial benefits.
To learn more, register to attend Ken Ziskin’s seminar on “Estate Planning for Apartment Owners”. His last seminar in 2016 (in conjunction with the Providence Little Company of Mary Foundation) will be at the Doubletree Hotel in Torrance on December 1 at noon, and includes a FREE lunch. 2017 Seminars with the AOA will be announced when they are scheduled. Ken also offers FREE CONSULTATIONS FOR AOA MEMBERS. You can call (818) 988-0949 to register for a seminar or arrange a free consultation.
Kenneth Ziskin, an estate planning attorney, focuses on integrated estate planning for apartment owners to save income, property, gift and estate taxes. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, a perfect 10 out of 10 rating from legal website AVVO.Com, and is multiple winner of AVVO’s Client Choice Award. See Ken’s website at www.ZiskinLaw.com. This article is general in nature and not intended as advice for clients. Please get advice from counsel you retain for your own planning.