Most of the apartment owners we have had the privilege to meet and work with are pretty frugal with their money.  They rarely live in the most expensive homes, drive the most expensive cars or buy the most expensive designer clothes. They are the “millionaires next door,” who built a solid financial foundation on sound investments and careful spending.

So, this month, let’s look at good estate planning from the viewpoint of frugal apartment owners who expect a good return on any investment they make – estate planning included.

In this article, we are going to compare the financial results of the typical estate plan that apartment owners bring to us in a consultation, with the results they project after we optimize their plans. 

Most of the estate plans we see were not drafted to optimize results under current law.  As a result, they impose “hazardous” income and property tax risks on the families of these owners, without achieving any offsetting Transfer Tax savings.  [Transfer Taxes include Estate (death) Taxes, Gift Taxes and Generation Skipping Transfer Taxes (which are imposed when property transfers to your grandchildren and their descendants).]

The deficiencies in most existing estate plans do not mean that such were done poorly.  Most of the time, the deficiencies and hazards that old plans produce stem from the fact that laws or the financial condition of the owners, changed after the plans were prepared.  Sometimes, of course, the problems stem from the planner’s lack of familiarity with, or sensitivity to, the special planning needs of apartment owners. 

You Don’t Need a Huge Estate to Save Money With Good Estate Planning

In the last century, with low estate tax rates, estate planning focused on saving Estate (Death) Taxes for those with estates larger than owners’ lifetime exemptions (around $600,000 per person for most of the 1990s).

In 2016, the exemption (now called an “exclusion”) has grown to $5.45 million per person, or nearly $11 million per couple, while the Estate Tax rate has fallen from 55% to 40%.  So, most apartment owners do not need good estate planning to save Estate Taxes.

But, even owners with only a million dollars or less need estate planning that focuses on maximizing the income tax and property tax benefits that can be left for their heirs.

Properly focused Estate Planning can help owners save hundreds of thousands of dollars in income and property taxes for their heirs.  Often, these savings total $100 or more for every dollar spent on good planning. 

[Even in smaller estates less than $2 million is size, the savings will usually exceed five or ten times the cost of the focused planning.  And, if you project your estate will be large enough to face estate taxes, there are strategies we use that can minimize or eliminate such taxes completely.]

This 100-to-one return on the cost of doing good planning can be even better when you compare it to the cost of generic planning done by lawyers who do not focus on issues important to apartment owners.  And, let’s face it:  with high income and proper tax costs in California, a dollar saved is like $1.50 to $2.00 earned! 

Bill and Bev’s Typical Apartment Owners’ Estate Plan

Bill and Bev Miller, ages 74 and 71, have owned property in California for decades.  Their property includes $5 million in apartments with an income tax basis, after depreciation, of $300,000 and a property tax assessed value of $500,000.  Their home is worth $1 million, with an income tax basis $200,000, assessed for property taxes at $350,000.  They also had $500,000 worth of other investment assets, mostly IRAs.

They held their real estate in joint tenancy until they transferred it to their living trust, and they did nothing to convert it to community property.  The living trust was last amended in 2004.  When they did their planning, they also put the apartments into an LLC and transferred a small portion of the LLC to their children, expecting that would save estate taxes for them.

Their estate plan includes a typical living trust structure, sometimes called an A-B Trust, which mandated that the maximum amount that could be passed without estate taxes at the death of the first spouse go into the “B” (often called a “Bypass” or “Credit Shelter” Trust).  The “B” Trust was mostly for Bev’s benefit, but did allow money to be distributed to children and grandchildren in the discretion of the Trustee.  The rest of the estate would go to a Survivor’s Trust for the surviving spouse. 

[Many existing plans include a “C” Trust to hold any property of the deceased spouse that could not be placed in the “B” Trust without generating estate taxes.  The “C” Trust would not change the tax results described below.] 

Tax Results of the Old Bev and Bill Plan

If Bill dies in 2016, and Bev in 2026, this “old fashioned” estate plan, which was originally designed to save estate taxes will save ZERO estate taxes, due to the expanded estate tax exclusion and the advent of portability that has made the “B” Trust largely unnecessary for most apartment owners.

But, the old plan will cost their heirs more than $1,000,000 in unnecessary income and property taxes! 

Where do those unnecessary taxes come from?

  1. Due to the failure to “transmute” their property from joint tenancy to community property, only Bill’s half gets a step-up in income tax basis when he dies.
  2. The LLC further reduces the Estate Tax value of the home and apartments.  In Bill and Bev’s case, that saves no estate taxes, but also reduces the step-up in basis at his death (and, later, at Bev’s death).
  3. The combined reductions in income tax basis can cost the Miller family big dollars in capital gains taxes (up to $900,000 if sold right after Bill dies) and big dollars ($30-50,000 per year after Bill’s death) in lower depreciation deductions while they own the property.
  4. By mandating that half the property go into the “B” Trust, that half does not get a second step-up in income tax basis when Bev dies.  If the property is sold thereafter, that could cost another $3-500,000 in capital gains taxes, or result in more regular income taxes due to decreased depreciation deductions if the property is kept for the Miller descendants after Bev’s death.
  5. The LLC causes the apartments to be reassessed at Bill’s death (due to quirks in the property tax law following Prop 13), raising property taxes by about $56,000 in the first year, with this unnecessary increase growing by 2% per year!
  6. The provision in the “B” Trust allowing distributions to children and grandchildren therefrom causes reassessment of half of the house, with an increase in property taxes of about $4,000 per year. 

Proper Restatement Could Have Avoided These Hazards

The Millers could have saved their heirs $1,000,000 or more if only they had restated their plan before one of them died.

Sound estate planning done with a lawyer who pays careful attention to the income and property tax issues relevant to apartment owners can avoid all of the hazards faced by the old fashioned plan of the Miller. 

Can You Beat the Return on Investment From Good Planning?

In today’s low rate environment, even apartment investments project lower average annual returns than they did years ago.

However, focused estate planning will save the heirs of most apartment owners 10, 20, 50, 100 or more dollars for every dollar they spend on the planning.  [For the Millers, the savings should be more than 200 to one!] 

Even better, the savings from good planning are not subject to erosion from the high income tax rates paid by Californians.  In most cases, savings from focused estate planning will produce a higher return than you can get even from putting a little more money into your apartment buildings.

Furthermore, customized estate planning also provides a number of non-tax benefits to your heirs in terms of liability and divorce protection, prevention of “affluenza,” and making sure your inheritance is not squandered.  Sometimes, these non-tax benefits are just “Priceless.”

So, spend the time to find out what hazards” lurk in your planning.  The, if you like the potential returns, invest the time and money with an experienced estate planning lawyer to create or update your plan. 

Remember our motto:  If you fail to plan well, plan to fail.” 

Drafting or restating your old trust just may be the best investment you could make for your heirs (other than those buildings you bought back when prices were a whole lot lower than they are today). 

Upcoming AOA Estate Planning Seminars

AOA will present Attorney Ziskin’s 2016 edition of “Estate Planning for Apartment Owners – Tips On How to Save Millions in Income and Property Taxes” in Northern California this May and in Southern California this June.  The 2016 edition adds segments on estate planning strategies that can reduce income tax liability when property is sold even during your life.  This is a FREE seminar!

The seminars are scheduled as follows:

  •        May 24 – Oakland (sorry this one is full)
  •        May 25 – San Jose (sorry this one is full)
  •        June 16 – Van Nuys
  •        June 21 – Buena Park
  •       June 28 – San Diego 
  •        June 30 – Torrance 

Attorney Ziskin will also host a booth at the AOA Million Dollar Trade Show on May 19, 2016 at the Long Beach Convention Center and would love to meet you there.       

Kenneth Ziskin is an estate planning attorney who focuses on integrated estate and tax planning for apartment owners.  He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, and a perfect 10 out of 10 rating from legal website AVVO.COM

Ken lectures frequently to professional and apartment industry groups and has written numerous articles on tax planning and other legal topics.  He recently rewrote AOA’s Special Report “Holding Title to Your Property –A Matter of Life, Death and Taxes…”

Ken’s website at www.Family-Wealth-Strategies.com includes information about his estate planning process and reviews of his work by his clients. 

Ken offers free consultations for AOA members who want to understand the “hazards” lurking in their plans, and can be reached at (818) 988-0949. 

This article is general in nature and not intended as advice on which owners can rely.   The case study represents the application of existing law to situations we have seen in our office, but every situation is different and laws can change.  Your savings from focused planning may be higher or lower.  Please get advice from counsel you retain for your own planning.