Take Care when using a Self-Directed IRA

March 29, 2023

For some people, a self-directed IRA could be a great vehicle in which to invest tax-advantaged retirement funds in real property. However, there are rules governing everything from property ownership and usage to how you cover expenses and take profits. If they aren’t followed, you can easily run afoul of the IRS. Take care when using a self-directed IRA.

Forbes’ recent article entitled “How To Use A Self-Directed IRA For Real Estate Investing” explains that a real estate IRA is just another name for a self-directed IRA that’s designed to hold investment property. You can own a wide range of property types in a real estate IRA. This includes land, single and multi-family homes, international property, boat docks, commercial properties and more. Because this is a type of self-directed IRA, the custodian—the company safeguarding your account and enforcing IRS regulations—allows you to hold alternative asset classes, like real estate.

First, find a custodian that allows or even specializes in real estate IRAs. Next, you need to fund your account—typically with a rollover from an existing IRA. With your cash in place, you can buy real estate and have it titled in the name of your IRA. You can finance real estate in your IRA with an investment property-specific mortgage. You can then pay the mortgage using additional cash from your self-directed IRA. When you sell a property held in a real estate IRA, the funds stay in the account. Depending on the type of IRA you’ve selected, those funds grow tax-deferred (traditional IRA) or tax-free (Roth IRA).

A real estate IRA allows you to diversify away from stocks and bonds. However, there are many rules governing this specialized type of account. Let’s look at some of the key rules you must know:

Property Title. Real estate that is held in a self-directed IRA is owned by the account, rather than by you personally. Therefore, the title documents that confirm ownership of the property are in the name of your IRA, rather than in your name.

Expenses and Income. All expenses and income flow into and out of your real estate IRA. All property taxes, utility bills and other expenses are paid by your account. All rental income or other income is paid back into your account.

Limitations on Use. Real estate held in a self-directed IRA can only be an investment property. You and any member of your family—plus any of your beneficiaries or fiduciaries—are referred to as disqualified persons. Since the purpose of an IRA is retirement investing, these disqualified persons can’t make use of the real estate assets.

No DIY. If you need to fix up or repair property held in a real estate IRA, the account must pay for the work. It can’t be performed by a disqualified person (you).

Prior Property Ownership. You can’t sell, lease, or exchange property you already own to your real estate IRA. That’s called “self-dealing,” which the IRS strictly prohibits.

Watch Out for the UBIT. If you take out a loan that’s secured by the property itself (a non-recourse loan), you will be required to pay unrelated business income tax (UBIT) on any profits related to the financed portion. However, you can use depreciation and operating costs to reduce your tax bill, which can allow you to reduce your UBIT or eliminate it altogether.

A self-directed IRA can be a wonderful tool to utilize retirement funds for real estate, but take care when using it. If you would like to learn more about retirement accounts and estate planning, please visit our previous posts.

Reference: Forbes (Feb. 13, 2023) “How To Use A Self-Directed IRA For Real Estate Investing”

Include your Memorabilia in your Estate Planning

March 20, 2023

Do you have a shoebox full of old baseball cards? Or perhaps an old collection of action figures from the many Star Wars movies? This memorabilia certainly has value to you, and you may want to pass it down to your family. The best solution is to include your memorabilia in your estate planning. Kiplinger’s recent article entitled “Estate Planning for Memorabilia Collectors: Don’t Leave Your Family in the Lurch” says the first step is to know what you have. Make a thorough and updated inventory to help your family understand the scale of the collection and where the items are located. Make sure the inventory is current and has detailed information about the items, like if a piece of memorabilia is signed or if it was game-used.

It’s also wise to log valuations along with the items’ description. You can try to stay on top of when comparable items sell at auction and follow industry publications to keep your valuations as current as possible. Every sector of collectible is different. Some items see their valuations fluctuate more than others. Even so, it’s helpful to have a ballpark idea of the total value of the collection. At some point, it might be worth hiring an appraiser to give you a formal valuation of the collection.

As far as authentication, many items need supporting paperwork to verify they’re legitimate. As you plan for your family to handle the sale of your items, they’ll need to know that those documents are an essential part of the collection and where they are.

When you’re walking them through your inventory, note where the items are identified as having separate certificates of authenticity and make sure they know where to find them. This can be as simple as using file folders.

When it comes time to sell, where does your family go Whether it’s sports memorabilia, coins, stamps, or just about anything else, there are dealers who are willing to purchase the collection. If you go into a collectibles shop that’s only buying items they plan to resell, you can expect to get about half of a collection’s actual value.

You can help your loved ones by making connections with auction houses that would be interested in bringing your collection up for sale. This can be a highly specialized area, so you’ll be saving your beneficiaries a big pain if you give them information about where they will get a fair price. Speak with your estate planning attorney about how to include your memorabilia in your estate planning. If you would like to learn more about managing personal property, please visit our previous posts.

Reference: Kiplinger (Feb. 26, 2023) “Estate Planning for Memorabilia Collectors: Don’t Leave Your Family in the Lurch”

Irrevocable Grantor Trust can reduce Tax exposure

March 16, 2023

Forbes’ recent article entitled “How To Pass On Business Assets While Paying As Little In Taxes As Possible” says that one of the first steps you’ll likely undertake in an estate plan is gifting assets so they’re not part of your estate. By gifting assets expected to appreciate over time—like company stock and real estate—into an irrevocable grantor trust and having those assets appreciate outside of your estate, you can reduce your estate tax exposure. Remember: the amount you can gift is restricted to you and your spouse’s combined lifetime federal estate and gift tax exemption ($25,840,000 in 2023).

As the grantor of the irrevocable grantor trust, you’ll be taxed on all income in the trust despite not receiving any of it. However, the payment of taxes from your estate reduces the value of your estate proportionately. Therefore, the assets in the trust can grow unburdened by taxation.

A drawback of gifting appreciating assets into a grantor trust is that the assets will retain the tax basis you, as the grantor, had when you gifted the assets. As the assets are no longer a part of your estate when you die, the assets you transferred to the grantor trust won’t get a step-up in basis to what their value is at that time. Capital gains taxation occurs when the trustee or beneficiary sells the appreciated assets.

Assuming that one of your goals for establishing the trust is to pay as little tax as possible, there are a few ways to avoid capital gains taxes inside a grantor trust.

As the grantor, you have the power to take trust assets back by buying them with cash or replacing them with other assets—low-appreciation ones are ideal. Therefore, if you get a large amount of your employer’s publicly traded stock, you might swap these shares for other publicly traded securities of equal value that have appreciated.

Since the assets traded must be equal in value, there shouldn’t be a change to your estate’s value used for calculating estate taxes. After the trade, you’ll own the highly appreciated stock. However, there won’t be a taxable gain when you pass away because you’ll get a step-up on the basis.

Likewise, for grantor trusts with appreciated real estate, an IRC §1031 exchange allows for capital gains taxes to be deferred when swapping one real estate investment property for another. Discuss with your estate planning attorney how an irrevocable grantor trust can reduce your estate tax exposure. If you would like to learn more about trusts and tax planning, please visit our previous posts.

Reference: Forbes (Dec. 22, 2022) “How To Pass On Business Assets While Paying As Little In Taxes As Possible”

Consider Annuities in your Estate Planning

March 2, 2023

Many people have annuities tied to their retirement accounts. It might be wise to consider annuities in your estate planning. Annuities are contracts between you and an insurance company, which is unlike retirement investment accounts like 401(k)s or individual retirement accounts (IRAs).

Forbes’ recent article entitled “What Is An Annuity Beneficiary?” explains that, with an annuity, you make a lump sum payment or a series of payments over a set period to the insurance company. In exchange, the insurance company will pay out a stream of income in retirement or at a predetermined future date, depending on the type of annuity purchased.

There are a number of benefits to annuities, such as a predictable income in retirement, tax-deferred growth and a death benefit if you pass away. There are several different types of annuities, but they can be grouped into three main categories:

Fixed annuity. If you buy a fixed annuity, the insurance company will pay you a minimum rate of interest and a fixed amount of periodic payments. These are the safest type of annuity because you know the minimum you’ll earn.
Indexed annuity. This combines features of annuities and investment securities. The insurance company’s payments are based on the performance of a stock market index, such as the S&P 500. When the index performs well, the value of the indexed annuity increases. However, it can also decline along with the index’s performance.
Variable annuity. With this type of annuity, you can use your annuity payments for investment products, like mutual funds. Your payout is based on the performance of how much you invest and the rate of return on those securities. These annuities can be risky. However, they have the potential for higher returns.

Whoever signs an annuity contract is considered the owner, who selects the way the annuity will be funded, how payouts will be made and the recipient of the payouts. They also name beneficiaries, control withdrawals and have the power to cancel the contract. An “annuitant” is the person who gets income payments from an annuity contract.

Some annuities have death-benefit provisions, so you can name someone to inherit the remaining annuity payments if you die before it’s been fully paid. The designated recipient of that benefit is known as the annuity beneficiary.

The death benefit of an annuity is typically the remaining contract value or the amount of premiums, minus any withdrawals, upon the annuity holder’s death. Discuss with your estate planning attorney whether or not you should consider annuities as part of your estate planning strategy. If you would like to learn more about annuities and how they work, please visit our previous posts.

Reference: Forbes (Jan. 19, 2023) “What Is An Annuity Beneficiary?”

Consider Portability as a Solution for your Surviving Spouse

March 1, 2023

If you expect to have a large portion of your unused estate tax exemption remaining, you might consider portability as a solution for your surviving spouse. Portability is a process in which any unused estate tax exemption can be transferred from the deceased spouse to the surviving spouse, according to a recent article from Ag Web, “Use Portability to Avoid a Potential Multi-Million Dollar Estate Mistake.”

What portability helps the surviving spouse to achieve is to put their assets in the best position to be transferred upon their death, to the next generation, with little or no estate taxes being owed.

In 2023, each spouse has a $12.92 million exemption from federal gift and estate taxes, but this high amount is set to drop about $6.6 million per person in 2026. Electing portability now will lock in the high exemption if a spouse dies before December 31, 2025, when the high exemption level ends.

The portability election does not happen automatically, and its critical to take this action, even if all assets were jointly owned and no taxes are owed when the first spouse dies. To elect portability, the surviving spouse must file form 706 Federal Estate Tax Return with the IRS.

Many financial advisors may not believe electing portability is necessary. However, it is. One estate planning attorney advises financial advisors and CPAs to obtain a written document affirming their decision from surviving spouses, if they decline to elect portability.

Portability is relatively recent to married farming couples. This is why many people in the agricultural sector may not be aware of it. An estate planning attorney can help the surviving spouse to file a Form 706. The value of assets may be estimated to the nearest quarter million dollars of value at the first spouse’s death.

Form 706 must be submitted to the IRS within nine months of the first spouses’ death. The deadline can be extended with the use of Form 4768 for an additional six months. However, if the surviving spouse misses the initial deadlines for filing, they can still elect portability up to five years from the date of their spouse’s death, by invoking “Relief under Revenue Procedure 2022-32.”

There were so many applications for extensions made to the IRS that in 2022, the change was made to give surviving spouses more flexibility in applying for portability.

Talk with your estate planning attorney to consider portability as a solution for your surviving spouse. If you would like to learn more about portability, please visit our previous posts.

Reference: Ag Web (Jan. 30, 2023) “Use Portability to Avoid a Potential Multi-Million Dollar Estate Mistake.”

Benefits of Creating a Life Estate

February 14, 2023

Today’s post discusses the significant benefits of creating a life estate. Quicken Loans’ recent article entitled “What Is A Life Estate And What Property Rights Does It Confer?” says by understanding the features of a life estate and creating one at the right time, you can enjoy several benefits, including the following:

Property Avoids Probate. Property in a life estate doesn’t go through probate. Instead, it just transfers ownership to the remainderman. This saves time and stress. It also eliminates the complications that arise when trying to spell out your intentions for your property in a will.

Property is No Longer Part of The Estate. Once your state’s Medicaid look-back period has passed, a property transferred through a life estate won’t count against your eligibility for the program.

Allows Seniors to Stay in Their Homes. Even though a life estate transfers property ownership to the remainderman, the life tenant has guaranteed residency, if desired, for the rest of the owner’s life.

While life estates are helpful, they have some drawbacks:

Property is Vulnerable to Debts Of Heirs. Because the life estate transfers property rights to a designated heir, his or her creditors may have the right to seize inherited assets to cover lingering debts, if there are any.

The Heirs’ Rights to The Property Vest at Creation. Once you create a life estate, the property rights vest in the heirs. You can’t take back those rights without the heir’s consent. As a result, some seniors use a living trust, in which its creator can always change the terms or cancel it entirely.

Property Can’t Be Sold or Mortgaged. If you want to significantly change the property, convert it into a rental, or even decide to sell, you must have the remainderman’s permission.

In sum, life estates help elderly homeowners create a straightforward, legal directive for an heir to inherit property without getting mired in probate.

Life estates also permit the owner to control the property in all respects, except they can’t sell or mortgage the property without the consent of their heirs. If created in a “timely” manner, a life estate can even help its creator qualify for Medicaid assistance.

However, life estates do have a few disadvantages.

As the life tenant, you’ll forfeit the ability to sell or mortgage your home without your heir’s permission. Since you can’t reverse a life estate without the consent of both the life tenant and remainderman, you should know all about the contract before committing to it. Discuss the potential benefits of creating a life estate with your estate planning attorney. He or she will have the experience to advise you if this strategy is best for your circumstances. If you would like to learn more about life estates, please visit our previous posts.

Reference: Quicken Loans (Aug. 9, 2022) “What Is A Life Estate And What Property Rights Does It Confer?”

Avoid leaving Co-op Ownership to Heirs

January 25, 2023

If you own a co-op you might be tempted to include it in your planning. It is wise to avoid leaving your co-op ownership to your heirs. Here is a cautionary tale.

Parents bought a studio apartment in a New York City co-op for their adult son with special needs. He’s able to live independently with the support of an agency.

The couple asked the co-op board to let them transfer the property to an irrevocable trust, so when they die, the son will still have a place to live. However, the board denied their request.

An individual with special needs can’t inherit property directly, or he’ll no longer be able to receive the government benefits that support him. What should the parents do?

The New York Times’ recent article entitled “Can I Leave My Co-op to My Heirs?” explains that parents can leave a co-op apartment to their children in their will or in a trust. However, that doesn’t mean their heirs will necessarily wind up with the right to own or live in that apartment.

In most cases, a co-op board has wide discretion to approve or deny the transfer of the shares and the proprietary lease.

If the board denied the request, the apartment will be sold and the children receive the equity. Just because the will says, ‘I’m leaving it to my children,’ that doesn’t give the children the absolute right to acquire the shares or live there.

In some instances, the lease says a board won’t unreasonably withhold consent to transfer the apartment to a financially responsible family member. However, few, if any, leases extend that concept to include trusts.

The parents here could wait to have the situation resolved after their deaths, leaving clear directives to the executor of their estate about what to do should the board reject a request to transfer the property into a trust for their son. However, that leaves everyone in a precarious position, with years of uncertainty.

It is safer to avoid leaving your co-op ownership to your heirs. Another option is to sell the co-op apartment now, put the proceeds in a special-needs trust and buy a condo through that trust. The son would then live there.

Unlike co-ops, condos generally allow transfers within estate planning, without requiring approval.

While this route would involve significant upheaval, the parents would have more peace of mind.

However, before buying the condo, an experienced estate planning attorney should review the building’s rules on transferring the unit. If you would like to read more about leaving real property to your heirs, please visit our previous posts.

Reference: New York Times (Oct. 1, 2022) “Can I Leave My Co-op to My Heirs?”

Proper Asset Protection Can Avoid a Receiver

January 5, 2023

The role of the receiver is often poorly understood. Many asset protection plans fail to address situations involving receivers. The vulnerable point of an asset protection or estate plan is where the wish to protect assets meets the desire to retain control, creating a weakness a receiver can exploit, says a recent article titled “Understanding Receivers For Collection And While Asset Protection Planning” from Forbes. Proper asset protection can avoid the costly involvement of a receiver.

The receiver has three roles: an officer of the court, an agent for the debtor’s estate (aka, creditors) and an agent of the debtor.

Receivers are appointed by the court. Most must take an oath to the effect that the receiver will follow the instructions of the court and post a bond against any misconduct. The receiver has no power to do anything until authorized by the court, which is usually part of the original order appointing the receiver.

The receiver reports to the court and usually submits monthly reports detailing their activities, expenditures and collections.

When the receiver’s work is done, they apply to the court for an order of discharge.

The receiver is an agent of the debtor’s estate, similar to how a trustee is the agent of the debtor’s bankruptcy estate. The debtor’s estate includes assets available to creditors for collection – this does not include exempt assets.

When a receiver is appointed, the receiver obtains a tax ID number for the estate and opens a bank account for the estate. As assets are liquidated, they are deposited into the account. Payment to the receiver for fees and expenses are paid from the account.

The receiver is ultimately acting for the benefit of creditors, so the receiver could be said to be an agent of creditors, although only the court may give the receiver instructions.

Third, the receiver is the agent of the debtor. As the agent of the debtor, the receiver becomes the debtor for nearly all purposes and if authorized by the court, can take any legal action the debtor could take.

For example, the receiver may execute deeds using the debtor’s name, exercise voting rights as to shares of stock or demand redemptions of stock or cancel contracts. The receiver may demand bank statements from a bank or give the U.S. Post Office instructions to forward mail to the receiver at their address. The receiver can also demand the debtors credit card statements, utility bills and anything else.

With the permission of the court, the receiver can literally take over the business, liquidate the assets of the business and cause the entity to be dissolved.

The level of intrusiveness of the receiver is such that the average debtor will make the effort to settle with their creditors to stop the receiver’s actions.

As an agent of the debtor’s estate, the receiver is likely to coordinate with the creditor. However, the receiver can only act as instructed by the court.

Asset protection needs to be done properly to avoid any involvement with a court-appointed receiver. If you would like to learn more about asset protection, please visit our previous posts.

Reference: Forbes (Nov. 17, 2022) “Understanding Receivers For Collection And While Asset Protection Planning”

Benefits and Drawbacks of Family Limited Partnerships

January 3, 2023

Being able to transfer wealth from one generation to the next is a good thing, especially now, when a big change is coming to the federal estate tax exemption amount, says a recent article titled “The Pros and Cons of Family Limited Partnerships” from The Wall Street Journal. The are benefits and drawbacks to Family Limited Partnerships.

In 2022, estates valued at up to $12.06 million are exempt from federal taxes. However, on January 1, 2026, the exemption sinks to around $6 million, with adjustments for inflation. As a result, wealthy Americans are now re-evaluating their estate plans and many are turning to the Family Limited Partnership, or FLP, as a tax saving strategy.

An FLP can be tailored to suit every family’s needs. You don’t have to be ultra-wealthy for an FLP to make sense. An upper-middle class family owning a small business or real estate properties they’re not ready to sell could make good use of an FLP, as well as a real estate mogul owning properties in multiple states.

There are some caveats. The cost of setting up an FLP ranges from $8,000 to $15,000. However, it can go higher depending on the state of residence and the complexity of the partnership. There are annual operating costs, tax filings and appraisal fees. The IRS isn’t always fond of FLPs, because there is an institutional belief that FLPs are subject to abuse.

The FLP needs to be drafted with an experienced estate planning attorney, working in consultation with a CPA and financial advisor. This is definitely not a Do-It-Yourself project.

What makes these partnerships different from traditional limited partnerships is that all partners are family members. There are two kinds of partners: general and limited. The parents or grandparents are usually the general partners. They contribute the bulk of the assets, typically a small business, stock portfolio or real estate. Children are limited partners, with interests in the partnership.

The general partners control all of the investment and management decisions and bear the partnership liability, even though their ownership of assets can be as little as 1% or 2%. They make the day-to-day business decisions, including funds allocation and income distribution. The ability of the general partner to maintain control of the transferred assets is one of the FLP’s biggest advantage. The FLP reduces the taxable estate, while maintaining control of the assets.

Once the entity is created, assets can be transferred to the FLP immediately or over time, depending on the family’s plan. The overall goal is to get as much of the property out of the general partners’ taxable estate as possible. Assets in the FLP are divided and gifted to limited partners, although this is often a gift to a trust for the limited partners, who are the general partners’ descendants. Placing the assets in a trust adds another layer of protection, since the gift remains outside of the limited partner’s taxable estate as well.

To avoid a challenge by the IRS, the partnership must be conducted as a business entity. Meetings need to be scheduled regularly, with formal meeting minutes recorded properly. General partners are to be compensated for their services, and limited partners must pay taxes on their share of income from the partnership. The involvement of professionals in the FLP is needed to be sure the FLP remains compliant with IRS rules.

An alternative is to create a Family Limited Liability Company instead of a Family Limited Partnership. These can be created to operate much like an FLP, while also protecting partners from liability.

Partnerships are not for everyone. Your estate planning attorney will advise regarding the benefits and drawbacks of Family Limited Partnerships, and whether an FLP or an FLLC makes more sense for your family. If you would like to learn more about family limited partnerships, please visit our previous posts.

Reference: The Wall Street Journal (Dec. 3, 2022) “The Pros and Cons of Family Limited Partnerships”

Photo by AV RAW

SLAT is Increasingly Popular for Married Couples

December 12, 2022

The most common estate planning technique used in 2020-2021, according to a recent article from Think Advisor, was the Spousal Lifetime Access Trust (SLAT). The SLAT has become increasingly popular for married couples at or above the current estate planning exemption level, as described in the article “9 Reasons This Popular Trust Isn’t Just for the Super-Wealthy.”

SLATs allow couples to move assets out of their estates and, in most cases, out of the reach of both creditors and claimants. Each spouse can still access the assets, making the SLAT a valuable tool for retirement.

In the past, SLATs were not used as often for clients with $1 million to $10 million in net worth. However, the SLAT accomplishes several objectives: optimizing taxes, protecting assets from creditors and addressing concerns related to aging.

Lock in Estate Tax Exemptions Among Uncertainty. SLATs are a good way to secure estate tax exemptions. Various proposals to slash the current estate tax exemptions before the sunset date (see below) makes SLATs an attractive solution.

Potential Restrictions to Grantor Trusts. There has been some talk in Washington and the Treasury about restricting Grantor Trusts. The SLAT eliminates concern about any future changes to these trusts.

Upcoming Change in Estate, Gift and GST Exemptions. When the 2017 tax overhaul expires in 2026, the gift, estate and generation skipping trust exemption will be cut in half. Now is the time to maximize those exemptions.

A Possible Planning Tidal Wave. There may be a big movement to act as 2026 draws closer and SLATs become a tool of choice. Before the wave hits and Congress reacts, it would be better to have assets protected in advance.

SLATs Work Well for Married Couples. Each spouse contributes assets to a SLAT. The other spouse is named as a beneficiary. The assets are removed from the taxable estate, securing the exemption before 2026 and assets are protected from claimants and creditors.

You Might Meet the Estate Tax Threshold in the Future. Even if your current estate doesn’t meet the high threshold of today, if it might reach $6 million in 2026, having a SLAT will add protection for the future.

Income Tax Benefits. A trustee can distribute funds and income to a beneficiary in a no-tax state, saving state tax income tax, or if the trust may be formed in a no-tax state and possibly avoid the grantor’s high home state income tax.

Asset Protection Planning. Many people don’t think about asset protection until it’s too late. By starting now, when assets are below $10 million, the asset protection can grow as wealth grows.

Shrinking the Need for Other Trusts. Depending on their financial situation, a couple may be able to use a SLAT trust and avoid the need for other trusts requiring annual gifts and Crummey powers. The SLAT may also eliminate the need to have a trust for their children.

While SLATs are becoming increasingly popular for married couples, it is important that you speak with your estate planning attorney to learn if a SLAT is appropriate for your family, now and in the near and distant future. These are complex legal instruments, requiring skilled professional help in assessing their value to your estate. If you would like to learn more about SLATs, please visit our previous posts.

Reference: Think Advisor (Nov. 16, 2022) “9 Reasons This Popular Trust Isn’t Just for the Super-Wealthy”

Photo by Vlada Karpovich

Category: Asset Protection

Take Care when using a Self-Directed IRA

Include your Memorabilia in your Estate Planning

Irrevocable Grantor Trust can reduce Tax exposure

Consider Annuities in your Estate Planning

Consider Portability as a Solution for your Surviving Spouse

Benefits of Creating a Life Estate

Avoid leaving Co-op Ownership to Heirs

Proper Asset Protection Can Avoid a Receiver

Benefits and Drawbacks of Family Limited Partnerships

SLAT is Increasingly Popular for Married Couples

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