When CRE is Part of Estate Planning

manhattan skyline

Russell J. Fishkind, author of “Probate Wars of the Rich and Famous,” recalled how in 1972 Harry Helmsley, one of the largest real estate owners in Manhattan, decided to leave his wife of 33 years, Eve. He then married a second time, connecting his life and business with a woman named Leona (she changed her last name many times). The NYC tabloid press later nicknamed her the “Queen of Mean.”

Eventually becoming chairwoman and chief executive of Helmsley Enterprises, Leona ruled over landmark properties: the Empire State Building, 230 Park Avenue, the Tudor City apartment complex, the New York Helmsley Hotel, the Ritz Carlton, the Helmsley Windsor, the Harley Hotel chain, the Carlton House, the Helmsley Middletowne and several Florida resorts. All in all, the Helmsley properties were collectively valued at to be worth about $5 billion dollars.

This story leads us to an example of how not to do estate planning.

Leona made modest provisions for her two grandchildren, but they came with strings attached. Leona required that they visit their father’s grave site at least once a year, and sign in when they do. Failure to sign in, and their interest in the trust ends. Leona also left $12 million to her dog, Trouble. A judge reduced this to about $2 million.

An even bigger mistake? Not clearly identifying the purpose of an enormous distribution to The Leona M. and Harry B. Helmsley Charitable Trust.

To avoid confusion when setting up a charitable trust, the term of the mission should be established. How long will it operate? What are the intentions?

Arguments over whether the Helmsley estate was actually worth 4 or 5 or 6 billion takes one directly to a problem encountered when using a percentage of the gross estate as a yardstick for valuation. Beneficiaries and other interested parties will sometimes argue over the valuation.

Why? Some parties might prefer either a higher or lower valuation for tax purposes. Or, if there is a charitable trust, a lower valuation means less money has to be given away. Accordingly, a fixed bequest may avoid this type of squabble.

Probate litigation — almost without fail — comes about from bad estate planning combined with any or all of these factors: a dysfunctional family, a second spouse and children from prior marriages, significant wealth involving a family business, an elder widow or widower who allegedly changed his or her intentions shortly before death, and either a tyrannical or dilatory fiduciary. These factors are the fuel for the fire of litigation.

The good news is there are several methods for avoiding the Helmsleys’ fate.

Wills

A will is the simplest estate planning device to prepare. With this document you can leave some or all of your property to the beneficiaries you choose. You can also use a will to name an adult guardian for your young children. The principal drawback of a will is that it must normally go through probate, a complicated and expensive court proceeding. Probate rarely benefits anyone except the lawyers.

Living Trusts, A Will Without Probate

A living trust is a legal document that’s similar to a will in function, except no probate or other court proceedings are required to turn property over to beneficiaries. Because of this capability, living trusts are the most popular probate-avoidance device.

3 More Ways to Transfer Property and Avoid Probate

  1. Payable-on-death accounts for bank deposits or securities (stocks and bonds).
  2. Joint tenancy, a form of ownership where the surviving owner(s) automatically receive the interest of a deceased owner without probate.
  3. Tenancy by the entirety, a special version of joint tenancy specifically limited to married people.

Step-Up in Basis for Real Property

One of the great advantages of passing on real estate or other highly appreciated investments or property is that your beneficiaries get what is called a “step-up in basis.” This value readjustment means they are not responsible for any income taxes on the appreciated assets when they are received.

IRA, 401K or Life Insurance?

Unless you are a surviving spouse, inheriting a traditional IRA or 401(k) means you are now responsible for the taxes owed. With the passage of the SECURE Act in 2019, most non-spouse beneficiaries are forced to fully withdraw a 401(k) or IRA within 10 years. This withdrawal is counted as ordinary income for beneficiaries, and taxed as such.

Another way to pass retirement accounts tax-free to your heirs is to purchase a life insurance policy where the annual life insurance premiums are funded by withdrawals from your retirement accounts. Similar to a Roth IRA, a life insurance death benefit passes tax-free to your heirs.

By converting a portion of your retirement accounts into life insurance, your beneficiaries are not stuck with a tax bill when they receive the funds. You can choose a life insurance policy that allows for cash-value growth so you can still access your funds for withdrawals in your lifetime.

1031: Exchanging Your Building for Like-Kind Property

Let’s say your firm outgrows its space or decides that it wants to buy or lease additional buildings. IRS code section 1031 allows you to do a tax-free exchange of a property for a like-kind property. Like-kind, in the case of commercial real estate and the 1031 Exchange, allows you to exchange one commercial building for another, but also for a variety of other real estate types, including raw land.

A family limited partnership is a limited partnership created by a family, usually the owners of a family business and/or investment/real estate portfolios. The general partner is often a parent who controls the partnership and is subject to unlimited liability. The limited partners, usually children, have minimal input and are only liable for the amount they invested. FLPs often form for federal and state gift and tax benefits and are powerful estate planning tools when used correctly. The problem? Many experts argue that FLPs are almost never correctly utilized, and because of this they often fail to produce their promised benefits.

An LLC can protect your personal assets from being used to pay creditors of your business. If you structure your estate to limit the potential impact of a malicious lawsuit or other attacks on your financial security, you may want to implement your LLC in conjunction with a Family Limited Partnership (FLP).

An FLP is another type of business organization that is comprised of general and limited partners. To avoid the liability inherent in an FLP, you can create and designate an LLC as the general partner of your FLP, naming yourself as the manager of the LLC. That structure places your assets out of the reach of creditors in most cases. If you minimally capitalize your LLC, within the limits of the law, you’ve insulated your assets from creditors. Obviously this organization is a bit costly and complicated to set up, so be sure to get expert counsel.

Flaws in FLPs

When it comes to estate planning, the flaws in FLPs include: parent as general partner, parent as both GP and only limited partner, and parent’s living trust as GP. The most common mistake is that when the parent is both the GP and the only LP, the courts can decide that the parent owns all the interests. Again, expert counsel is recommended.

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