After presenting the July seminar on estate planning for apartment owners, I had the privilege to review the estate plans of dozens of owners. The review confirmed my concern about common mistakes in estate planning by apartment owners.
I know, from my meetings with many owners, that they almost universally say that they want their planning to accomplish the following goals for their wealth:
- Take care of us (or the survivor of us) while we are alive;
- Minimize taxes;
- Maximize the wealth we can pass for use by our children and grandchildren after we are gone;
- Protect what we leave for our heirs so that they, and not any creditors or ex-spouses, will get the benefit of our hard earned investments.
Lessons from Reviewing Apartment Owners’ Estate Plans
Most of the plans I reviewed met the first goal pretty well. However, not a single plan met all of the next three goals, and many failed in more than one aspect. Almost every plan had provisions that would lead to unnecessary reassessment of property taxes. In some cases, the unnecessary additional property tax liability over the projected ownership of the properties equaled 20-30% of the value of the apartments!
Only one plan maximized step-ups in basis on the death of both spouses. Many estate plans did not even maximize the step-up on the death of the first spouse to die, which meant that the survivor would not be able to maximize post-death depreciation deductions. The projected unnecessary tax cost of these failures ranged from 15% to more than 40% of the value of the owners’ apartments.
The unnecessary tax costs of those plans, if not corrected, would seriously impair the wealth available to the owners’ children and grandchildren. To make matters worse, almost all of the plans failed to protect the inheritance left for children and grandchildren from the ravages of their creditors and potential ex-spouses.
The New World of Estate Planning
When “The American Taxpayer Relief Act of 2012” (“ATRA”) became law in 2013, many of the principles used for good estate tax planning before that went out the window.
Before ATRA, the tax part of estate planning for apartment owners usually focused on reducing or eliminating the dreaded “death” tax (estate tax).
However, the expansion of the amount you could exclude from estate taxes under ATRA, coupled with increases in California and Federal income tax rates, made it much more important for (most) apartment owners to refocus their planning on income tax and property tax savings. Now, if you leave an estate of less than $5.34 million as an individual, or $10.68 million as a married couple, estate taxes are no longer a problem.
Unfortunately, older planning designed to maximize estate tax exemptions came at a fearful cost: it usually reduced the step-up in basis at death. That reduction in the step-up becomes more significant from a combination of (i) higher income tax rates (the combined maximum rate in California can now exceed 50%!) and (ii) the run-up in apartment values as interest rates and capitalization rates declined dramatically.
As a result, many estate plans for apartment owners contain unnecessary features to protect against estate taxes, while the expanded exemptions and a new concept of portable exemptions among spouses eliminated estate tax exposure for most owners.
If these estate tax oriented features were only unnecessary, and not potentially harmful, we could just ignore them.
No Harm, No Foul, No Longer
Now and especially given the much higher income taxes faced by California apartment owners, these unnecessary features are more than mere surplusage. They can actually cost your heirs hundreds of thousands, or even millions, of dollars in additional income taxes.
Taxes Are Important, but Non-Tax Planning Is Equally Important
Clients understand that unnecessary taxes detract from the utility of their wealth, both for themselves and their heirs.
Yet good non-tax planning remains important as well. It can protect the inheritance you leave behind from pesky creditors and predators (ex-spouses). It can encourage your heirs to maximize their potential. It can help you pass your core values down multiple generations. And, it can minimize, or provide a structure to deal with, conflicts among heirs.
My Crazy Eight Most Common Estate Planning Errors by Apartment Owners
Every estate planning attorney has a few pet peeves about the planning he sees done by others. Here are the top eight mistakes that I have seen in estate plans that apartment owners have asked me to review:
8. Failure to protect the inheritance owners leave from creditors of their heirs.
7. Failure to protect the inheritance from divorce risks and ex-spouses in a world where 50% of marriages end in divorce.
6. Sprinkling provisions in trusts that lead to reassessment for property tax purposes.
5. Use of LLC or limited partnership structures that lead to unnecessary property tax reassessment.
4. Use of Credit Shelter, Bypass, Family or “B” trusts that reduce step-ups in basis when the second spouse dies.
3. Failure to properly convert joint tenancy property to community property, which prevents the surviving spouse from getting a full step-up in basis when the first spouse dies.
2. Failure to customize the non-tax aspects of your plan to fit your family.
1. Failure to adjust your plan to a changing tax environment or family changes.
How to Learn More
The AOA will present two FREE seminars on “Estate Planning for Apartment Owners” at 10 A.M on November 19th in Van Nuys, and on November 20th in West Los Angeles. At the seminars, I will help apartment owners understand the principles behind modern estate planning as it applies to apartment owners, and show them strategies that could save millions of dollars in taxes.
BONUS: As a bonus, attendees will receive a certificate entitling them to a free review of their existing estate plan, along with a personalized, no obligation consultation about their plans.
Advance reservations are required. You can register online at www.aoausa.com or call the AOA office at 818-988-9200, ext. 132, or call my office at 818-988-0949. And, remember my motto: “IF YOU FAIL TO PLAN (WELL), PLAN TO FAIL”.
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. Ken’s website is www.Family-Wealth-Strategies.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.