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1 Schwabe, Williamson & Wyatt’s Real Estate and Business Seminar Series Tax Saving Strategies for Apartment Building Owners March 8, 2006 Seattle, WA.

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Presentation on theme: "1 Schwabe, Williamson & Wyatt’s Real Estate and Business Seminar Series Tax Saving Strategies for Apartment Building Owners March 8, 2006 Seattle, WA."— Presentation transcript:

1 1 Schwabe, Williamson & Wyatt’s Real Estate and Business Seminar Series Tax Saving Strategies for Apartment Building Owners March 8, 2006 Seattle, WA

2 2 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.

3 3 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

4 4 Overview of Current Tax Regime Federal Estate Tax Year of DeathFederal Estate Tax Exempt Amount 2006$2 million 2007$2 million 2008$2 million 2009$3.5 million 2010Repeal (no tax) 2011 and After$1 million

5 5 Overview of Current Tax Regime Federal Gift Tax Year of DeathFederal 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 2010Repeal (no tax)$1 million 2011 and After$1 million

6 6 Overview of Current Tax Regime Washington State Estate Tax Year of DeathFederal 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 2010Repeal (no tax)$1 million$2 million 2011 and After$1 million $2 million

7 7 Harry and Sally’s Family Tree Harry Sally Jennifer Jake Mary Julie Mark David Jason Justin Emma Claire EvaAlex

8 8 Harry and Sally’s Assets AssetValue 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

9 9 Simple Will Harry’s Share $5 Million Sally’s Share $5 Million Case #1 No Tax Planning (Simple Wills) Harry and Sally’s Estate $10 Million Harry Dies Sally Dies (all subject to taxes) Sally’s Estate $10 Million

10 10 State Credit Shelter Trust $2 Mil Fed Credit Shelter $1.5 Mil Marital Trust $1.5 Mil Harry Dies Harry’s Share $5 Million Sally’s Share $5 Million Sally Dies 1/3 Julie’s Share 1/3 Jennifer’s Share 1/3 Jake’s Share Harry and Sally’s Estate $10 Million Case #2 Basic Estate Tax Planning

11 11 Pros:Cons: Saves substantial taxes Ensures first spouse’s 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 spouse’s death Somewhat more expensive to prepare Wills with Credit Shelter Trusts Requires trust administration Case #2 Basic Estate Tax Planning

12 12 Member and Co-Manager Member and Co-Manager Case #3 Family LLC Structure Harry 50% Sally 50% Apartment A, LLC

13 13 Case #3 Discounts of LLC Interests Lack of marketability –30% to 35% Lack of control –44% (Trusts & Estates) ¼ exceeded 60%! Rev. Ruling –IRS “throws in the towel”

14 14 Case #3 Family LLC Strategy Apartment A $3 Million Owned by Harry and Sally Jointly All three apartments Total: $9 million Apartment A, LLC Harry 50% Sally 50% Discounted 35% $1,950,000 All three LLCs Total: $5,850,000

15 15 What, me worry?

16 16 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?

17 17 Family LLC Strangi Than Fiction Waited too long (two months before death) Transferred too much to FLP (did not retain enough for Strangi’s needs) FLP paid Strangi’s bills FLP did not conduct any active business THE “SNIFF” TEST: Did the parties actually do what they said they would do?

18 18 Family LLC Tips to Avoid an Audit Don’t wait until you are in ill health Do what you say you intend to do Don’t 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 Don’t be greedy!

19 19 Pros: Cons: 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 Case #3 Family LLC 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

20 20 Case #4 Family LLC With Gifting Program Apartment A, LLC Harry 50% Sally 50% Children and Spouses Up to $12,000 each per year Grandchildren’s Trusts Up to $12,000 per year, per beneficiary

21 21 Case #4 Year 1 Gifts

22 22 Case #4 Year 4 Gifts

23 23 More Pros: More Cons: 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 Case #4 Family LLC With Gifting Program Cost of appraisal Pro rata distributions can impact cash flow Some audit risk, if not done correctly

24 24 Case #5 Grantor Retained Annuity Trust (GRAT) Apartment B, LLC Harry 50% Sally 50% Value: $1,950,000 GRAT 10 Years $195,000 / yr To H & S Gift tax exemption used: $1,070,000 Value: $ 3,570,000 Jake 33% Jennifer 33% Julie 33% Apartment B, LLC

25 25 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 Case #5 Grantor Retained Annuity Trust (GRAT)

26 26 Case #6 Intentionally Defective Income Trust Apartment C, LLC Harry 50% Sally 50% Note to H & S $110,000 / yr Apartment C, LLC Jake 33% Jennifer 33% Julie 33% IDIT Sale 60% 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

27 27 Pros: Cons: 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 Requires trust administration for term of note Limited audit risk, if properly valued and documented Case #6 Intentionally Defective Income Trust

28 28 Questions? Schwabe, Williamson & Wyatt’s Real Estate and Business Seminar Series Thank you.

29 29 About the Presenters Dennis A. Ostgard is a 1978 graduate of Harvard Law School, and leader of Schwabe, Williamson & Wyatt’s 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. 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.


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