Schwabe, Williamson

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Schwabe, Williamson Wyatts
Real Estate and Business Seminar Series
Tax Saving Strategies for Apartment Building
Owners March 8, 2006 Seattle, WA
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IMPORTANT NOTICE

• To comply with IRS regulations, we are required
  to inform you that this presentation, if it
  contains advice relating to federal taxes, cannot
  be used for the purpose of avoiding penalties
  that may be imposed under federal tax law. Any
  tax advice that is expressed in this presentation
  is limited to the tax issues addressed in this
  presentation. If advice is required that
  satisfies applicable IRS regulations, for a tax
  opinion appropriate for avoidance of federal tax
  law penalties, please contact an Schwabe attorney
  to arrange a suitable engagement for that
  purpose.

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Our Goals Today

• Learn several tax saving strategies
• Understand why and how each strategy works
• Know the pros and cons of each strategy
• Learn to avoid or minimize risk of IRS audit

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Overview of Current Tax Regime Federal Estate Tax
Year of Death Federal Estate Tax Exempt Amount
2006 2 million
2007 2 million
2008 2 million
2009 3.5 million
2010 Repeal (no tax)
2011 and After 1 million
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Overview of Current Tax Regime Federal Gift Tax
Year of Death Federal Estate Tax Exempt Amount Federal Gift Tax Exempt Amount
2006 2 million 1 million
2007 2 million 1 million
2008 2 million 1 million
2009 3.5 million 1 million
2010 Repeal (no tax) 1 million
2011 and After 1 million 1 million
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Overview of Current Tax Regime Washington State
Estate Tax
Year of Death Federal Estate Tax Exempt Amount Federal Gift Tax Exempt Amount Washington Estate Tax Exempt Amount
2006 2 million 1 million 2 million
2007 2 million 1 million 2 million
2008 2 million 1 million 2 million
2009 3.5 million 1 million 2 million
2010 Repeal (no tax) 1 million 2 million
2011 and After 1 million 1 million 2 million
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Harry and Sallys Family Tree
Harry
Sally
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Harry and Sallys Assets
Asset Value
Home 700,000
Apartment A 3,000,000
Apartment B 3,000,000
Apartment C 3,000,000
Other Assets 300,000
Total Assets 10,000,000
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Case 1 No Tax Planning (Simple Wills)
Harry and Sallys Estate 10 Million
(all subject to taxes)
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Case 2 Basic Estate Tax Planning
Harry and Sallys Estate 10 Million
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Case 2 Basic Estate Tax Planning
Pros
Cons

• Saves substantial taxes
• Ensures first spouses estate goes to intended
  heirs
• Do not need to set up trusts during lifetimes of
  both spouses

• Must be included in Wills prior to first spouses
  death
• Somewhat more expensive to prepare Wills with
  Credit Shelter Trusts
• Requires trust administration

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Case 3 Family LLC Structure
Member and Co-Manager
Member and Co-Manager
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Case 3Discounts of LLC Interests

• Lack of marketability
• 30 to 35
• Lack of control
• 44 (Trusts Estates)
• ¼ exceeded 60!
• Rev. Ruling 93-12
• IRS throws in the towel

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Case 3 Family LLC Strategy
Discounted Value _at_ 35 1,950,000
All three apartments Total 9 million
All three LLCs Total 5,850,000
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What, me worry?
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Family LLC Strangi Than Fiction

• 11 million transferred to FLP
• Strangi died two months later
• Heirs claimed 40 discount
• RESULT Taxed on the full 11 million!
• WHY?

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Family LLC Strangi Than Fiction

• Waited too long (two months before death)
• Transferred too much to FLP (did not retain
  enough for Strangis needs)
• FLP paid Strangis bills
• FLP did not conduct any active business
• THE SNIFF TESTDid the parties actually do
  what they said they would do?

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Family LLC Tips to Avoid an Audit

• Dont wait until you are in ill health
• Do what you say you intend to do
• Dont contribute personal-use assets
• Keep out enough to meet personal needs
• Respect the form of entity (separate
  books, state and federal filings, etc.)
• FLLC is not your personal checkbook
• Distribute cash pro rata
• Dont be greedy!

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Case 3 Family LLC
Pros
Cons

• Requires that business formalities are followed
  (separate books, meetings, reports, tax returns,
  etc.)
• Cost of set up and administration
• Lender consent may be required
• Some audit risk, if not done correctly

• Saves substantial estate taxes
• Limits owner liability
• Efficient management
• Keeps business in family
• Makes it easy to transfer fractional interests
• Distributions tax-free to extent of basis
• No real estate excise tax

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Case 4 Family LLC With Gifting Program
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Case 4 Year 1 Gifts
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Case 4 Year 4 Gifts
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Case 4 Family LLC With Gifting Program
More Cons
More Pros

• Cost of appraisal
• Pro rata distributions can impact cash flow
• Some audit risk, if not done correctly

• Further tax savings (gift tax exclusions and
  discounts)
• Allows heirs to begin participation in business
• Avoids complications of co-tenancy
• Spendthrift protection
• Provides a mechanism for pooling investment
  assets

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Case 5 Grantor Retained Annuity Trust (GRAT)
Gift tax exemption used 1,070,000
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Case 5 Grantor Retained Annuity Trust (GRAT)
Pros
Cons

• Retains identifiable cash flow
• Transfers significant appreciation to heirs
• Saves substantial taxes
• No audit risk, if you comply with statute

• Requires that Grantors survive the term of the
  trust
• Requires current use of Gift Tax exemption
• Does not facilitate transfers to grandchildren
  (GST exempt transfers)
• Requires trust administration

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Case 6 Intentionally Defective Income Trust

• Harry and Sally retain 40 LLC interests
• Harry and Sally contribute 117,000 in seed
  money

• Harry and Sally take back a 15-year fully
  amortizing note

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Case 6 Intentionally Defective Income Trust
Pros
Cons

• Requires trust administration for term of note
• Limited audit risk, if properly valued and
  documented

• Retains identifiable cash flow
• Saves substantial taxes
• Does not require current use of Gift Tax
  exemption
• Transfers significant appreciation to heirs
• Facilitates transfers to grandchildren (GST
  exempt transfers)
• Does not require Grantors to survive term

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Schwabe, Williamson Wyatts
Real Estate and Business Seminar Series
Questions?
Thank you.
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About the Presenters

• Susan L. Peterson is a 1987 graduate of
  Harvard Law School, who focuses her practice in
  the areas of real estate, business transactions,
  and business entity formation, including
  commercial real estate transactions, business
  sales and acquisitions, business entity
  selection, and estate and succession planning for
  business owners.

• Dennis A. Ostgard is a 1978 graduate of
  Harvard Law School, and leader of Schwabe,
  Williamson Wyatts real estate and business
  practices in the Seattle office. His practice
  emphasizes commercial real estate transactions,
  leasing and development projects, business sales
  and acquisitions, and business entity selection.