We are likely, but not assured, to see more tax changes in this administration than we have seen in decades, maybe more than any of us have seen in any other administration during our lifetimes.
As I write this, we do not yet know the precise parameters that will result from tax reform after the election of President Trump. But, the odds are that, sometime during Trump’s administration, Congress will enact, and he will sign, one or more tax reform measures. However, for the vast majority of apartment owners, the changes may have very little effect on their estate planning.
The generous lifetime exclusion from estate and gift taxes (now $5.49 million per person, and nearly $11 million per couple) already effectively repealed the estate and gift tax for 99.7% of American families, and probably protected 80%+ of apartment owners as well.
Yet, despite the fact that estate taxes became largely irrelevant for most of you four years ago, many apartment owners still have estate plans that remain “hazardous” to family wealth. These “hazards” include: (i) unnecessary property tax increases, (ii) unnecessary income tax exposure for your heirs; and (iii) the risk that your heirs will lose their inheritance to creditors and “predators” (future ex-spouses of your children, grandchildren and other heirs).
Worse, for all but the wealthiest apartment owners, unnecessary exposure to the most significant liability faced by an aging population – the huge cost of long-term care as we live longer than our parents did – can wipe out much of your inheritance, and imperil the financial security of even a spouse who does not need long-term care.
Fortunately, specialized updated planning can eliminate or mitigate all of these hazards for most apartment owners. In fact, when it comes to the financial catastrophe of long-term care, quirks in the law can actually allow sound planning to protect the wealth of apartment owners even better than other investors!
However, these quirks are likely to be temporary, and face restriction when California finally conforms to rules other states adopted in accordance with the Deficit Reduction Act of 2005.
Given the timeliness of these issues, the AOA has scheduled us for seminars in Van Nuys and Torrance this March. We hope to repeat the seminar for AOA members later in the year in Northern California (probably in June), Orange County and San Diego (dates to be determined).
We also expect that, by the time of the seminar(s), we may have an update on likely tax reform proposals, as well as possible effective dates. Many commentators believe that other priorities will delay the effectiveness of tax reform until 2018 or 2019.
A “Cloudy” Crystal Ball
Until Congress finishes the sausage-making process of legislation, no one can accurately predict what tax reform will look like, or even when it will become effective. The history of tax reform by new administrations is littered with grand proposals that never made it into law. Our system is full of checks and balances, exacerbated by thousands of alligators in the swamp (lobbyists).
This makes it difficult for even a President whose party controls both houses of Congress to get them to adopt all of his priorities. And, sometimes the reality of governing, or the need to fund other programs, forces a President to scale back or defer the tax reform he promised in his campaign.
Furthermore, the “devil is in the details,” and campaign proposals contain very few of these. Often, when an admin-istration looks at the details, it realizes that some grand ideas may not work as well as anticipated, or may have serious, unintended consequences.
Recognizing that these uncertainties make it impossible to predict what tax reform will really do, let’s look at the outlines proposed by the Republicans and President Trump. We have very good news on individual income tax rates. Both want to have just three brackets of Federal income tax: 12%, 25% and 33%. Both would eliminate the 3.8% tax on Net Investment Income that came in with Obamacare. Both want to significantly reduce the corporate tax rate, and would eliminate the individual and corporate Alternative Minimum Tax.
On the “bad news” side, both would limit the standard deduction, and the President would like to enact caps on itemized deductions of $100,000 for individuals, and $200,000 for married couples. This could greatly reduce deductions for those who have significant mortgages and deductions for state taxes, both of which have more importance for California real estate owners than in the rest of the country.
Both also want to eliminate the “Death Tax” – the Estate Tax. The GOP blueprint would also eliminate the Generation Skipping transfer tax, but keep the gift tax (the President’s sketchy campaign outline was silent on these).
Capital gains taxation is harder to predict right now. Both want to keep the 20% rate, but the President’s plan would tax unrealized capital gains at death (similar to the Canadian system). He would exempt the first $10 million (though it is unclear if that means gains on the first $10 million of assets, or the first $10 million of gains (again, the GOP blueprint is silent on this). The President also indicated there would be some indefinite exemption for gains on small businesses and family farms. Rental real estate is not treated as an active business in most other parts of the law, so we would not predict that the small business exemption would apply to your apartment building holdings.
While the step-up in basis may not apply fully for federal purposes, it may remain important for California taxpayers, who face taxes on capital gains as high as 13.3%.
If the gift tax is eliminated, and step-up in basis at death is either eliminated, or, worse, some unrealized gains face capital gains taxes at death, many of the gifting strategies and tools we now use to protect against estate taxes for wealthy clients may remain relevant to protect against capital gains taxes after death.
On balance, we believe that the likeliest estate tax changes in President Trump’s proposals will NOT lead to changes in how most living trust plans are structured. Furthermore, the history of death tax repeal in the United States suggests that planning to avoid estate taxes remains relevant for the wealthy. Death taxes were enacted in 1797, 1862, 1898, and 1916. Some were repealed a few years later, only to return soon. Even the “repeal” of the Revenue Act of 2001 lasted only for the year 2010!
The Biggest Liability Exposure of Apartment Owners
We are always amazed by how concerned our clients are about liability exposure to their tenants, despite the paucity of substantial damage awards to tenants, and the ease of insuring against those awards. Thousands of apartment owners have established limited liability companies with the hope of protecting against these awards.
Despite the very imperfect protections these LLCs provide, these LLCs caused their owners to suffer substantial legal costs, state fees, reductions in step-ups in basis to protect against income taxes and reductions in the ability to pass favorable property tax assessments to heirs.
Yet very few clients do anything to protect against their far more likely exposure to long-term care expenses. These liabilities can easily exceed $1 million for a couple, and can go up to $5 million or more! Worse, these liabilities can force you to sell appreciated properties and incur huge capital gains taxes.
Medicaid in other states, and Medi-Cal in California, were designed to protect those of limited means from the devastation of long-term care costs. While some of you will never face those costs, most of us will live longer than our parents, and much of that life extension may include long periods where we need extensive care. Fortunately, the vast majority of long-term care facilities accept Medi-Cal, so use of Medi-Cal does not limit you to substandard facilities.
Through income and property taxes, you probably paid more to support Medi-Cal than the average taxpayer, and deserve to be able to get some of that back if you need long-term care. However, Medi-Cal rules are designed to make you consume almost all of your hard-earned wealth, and impoverish yourself and your spouse, before you become eligible for Medi-Cal long-term care. And, although some property may be exempt from the eligibility tests, the rules allow the state to recover that property to cover what it spent on your care after you and your spouse die! This can work like a 100% death tax.
Fortunately, sound planning techniques exist which can protect millions from being consumed for long-term care and still allow Medi-Cal to pay your long-term care costs. These techniques work best if done in advance (at least 30 months before you need the care), and while you are legally competent.
For those who “fail to plan”, other techniques (which California will limit someday to meet the requirements of the DRA) can preserve some (and occasionally, all) of your wealth for your family. While these “crisis” techniques still work, they usually preserve less than sound pre-planning will, while at greater cost. At best, delay reminds me of the 1972 Fram Oil Filter ad: “Pay me now, or pay me later.”
In the right case, good pre-planning can preserve and protect several millions in wealth for your spouse and your heirs, while making funds available to supplement what Medi-Cal provides. In our March seminars, we will give you a better perspective on planning to protect you and your estate from impoverishment due to long-term care needs.
Customize Your Estate Plan So It Works Well for You and Your Family
The real key to make your estate plan work is good planning that is customized to your needs and desires. Good planning is flexible, and designed to take into account likely changes in tax law, your wealth and the financial environment.
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. And, remember our motto: “IF YOU FAIL TO PLAN (WELL), PLAN TO FAIL”.
FREE Estate Planning Seminars
To learn more, register to attend Ken Ziskin’s seminar on “Estate Planning for Apartment Owners”. Seminars are scheduled for:
- Thursday, March 23, 2017 at the AOA Office in Van Nuys
- Tuesday, March 28, 2017 in Torrance at the Holiday Inn.
To register for one of these seminars, call (800) 827-4262 today!
Kenneth Ziskin, an estate planning attorney and AOA member, works with his wife Hinda, to provide integrated estate planning for apartment owners to save income, property, gift and estate taxes, and protect apartment owners from long-term care exposure. 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. It includes reviews by many of his clients. This article is general in nature and not intended as advice for clients. Please get advice from counsel you retain for your own planning. To arrange a FREE consultation, AOA members can call Ken at (818) 988-0940.