Estate Planning for Real Estate Pros, Part 3: Gifting and More

In this final installment of our three-partner on estate planning, John VanDuzer and Suzanne Forbes cover a wide range of estate tax and gifting strategies. They also discussed step ups on death and the changing estate planning environment.

Gifting

If your net worth exceeds $12.92 million when you pass away, your estate is taxed on the amount above that threshold by as much as 40%. In 2026, the estate tax exemption is scheduled to roll back to the pre-2018 level of $5 million, as adjusted for inflation (anticipated to be in the $5-7 million range). If you’re in real estate, you know that this isn’t a tough ceiling to hit given industry growth.

This is why people often employ gifting strategies in their estate plan. This allows you to transfer ownership of some assets—thereby removing them from the value of your estate—while still retaining some level of control or influence over them.

There are several methods to gifting, but they all start with the same first step: Protect your net worth, look at your assets and identify those that will be worth a lot more in the future.

“If I have a piece of property that I bought for half a million today, but by the time I build it out and lease it it’s going to be worth $3 million, how can I get that difference out of my estate so it won’t be taxable?” said Suzanne. “So those are the gifting strategies we start with. What assets do you have, what assets are going to be highly appreciating? And then, what the best way to potentially get them out of your estate today?”

A Matter of Trust(s)

One simple way to do this is to gift to your family outright by putting property in an LLC and gifting them membership interests. Then you would establish voting and non-voting shares of membership interest, with you retaining the voting shares. This means you still control whether the property is sold or how distributions are made, even if that voting interest covers only 1% of the shares. This is a suitable solution if you don’t have many assets, or those assets are not an operating trade or business from which you receive rental income.

For more complicated estates, however, assets are gifted into type of irrevocable trust called a GST exempt trust. Often used to create a dynasty trust for kids and grandkids, it allows you to specify what happens to your assets and the income they generate.

The value of the gift is what the assets are worth at the time you put them in the trust. This means any increase in value is not part of your taxable estate when you ultimately pass away.

“In the tax law, there are trusts we can set up for transfer purposes, for estate purposes, that are a separate identity, and they’re not included in your estate,” said Suzanne. “For income tax purposes they’re as if they don’t exist. And that gives us a lot of opportunity.”

An intentionally defective grantor trust (also called an IDGT or defective trust) is a common estate planning tool. It in essence “freezes” your net worth for estate tax purposes. However, you still pay income tax on the income earned by the assets. The assets in the trust grow tax free and are not considered a gift. The IRS has also ruled that the tax that you pay on the income is not a contribution to the trust (and therefore not a gift).

John explained further with an example of an estate growing at a 5% interest rate. The estate holder sells a piece of land so an interstate interchange can be built on it. The value of that land will increase drastically, leading to a 20% rate of return as part of the trust.

“The trust is getting the benefit of that growth and only paying down the nominal interest over your lifetime. And then you’re also paying taxes on the income, which means you’re spending your assets down even more,” he said. “It’s a strategy of, ‘Let me freeze my estate, let me slow down the growth, let me move the high value assets over, let me pay the taxes on those assets over my lifetime and deplete my assets, so that way, when I pass, in a really long time, all the value is sitting in that trust.’”

Suzanne also mentioned the spousal lifetime access trust (or SLAT), an option popular with high wealth individuals. While similar to a defective trust, the initial beneficiary is your spouse. Generally, one half of the estate is gifted from one spouse to the other and vice versa. This removes the assets from their combined taxable estates to reduce total value, and both spouses can still use income from those assets during their lifetime. When one spouse dies, their income goes to their heirs while the surviving spouse lives off of their own half.

While a SLAT allows for legacy planning for such couples, you could face complications if the marriage ends. Divorce generally terminates a spouse’s indirect access to the assets through their former partner. So it’s important to include language in a SLAT agreement directing how divorce would be handled.

The final type of legacy trust discussed was the grantor retained annuity trust, or GRAT. This strategy is used to transfer future growth on appreciating assets with little to no gift or estate tax consequences. It also pays the grantor an annuity, providing cash flow for a period of time.

“The value of the gift is really dependent on the spread on the rate of return of those assets versus the IRS annuity rate that you discount the gift by,” said John. “So what can end up happening is you can give a gift and it has a nominal use of your estate tax or gift tax exemption—a hundred thousand dollars. But if you have a really high rate of return on those assets, you could be gifting millions of dollars. The catch is that it’s 10 years from now, and you have to live the entire 10 years for it to actually work.”

Trusts can also be used if you’d like make large gifts from your estate to charity while you’re still living. When you donate assets upon your death, you receive a deduction so their value isn’t included in your estate. But what if you want to see the impact of your generosity during your lifetime?

“That’s where we’ll see charitable trusts set up,” said Suzanne. “There are annuity trusts, remainder trusts, all sorts of charitable trust-type of giving. You can either put the assets in a trust and get an income stream off of them, or you can leave a remainder.”

Step Up to Step-Up Basis

Sometimes it pays to transfer ownership of an asset after your passing—particularly when it comes to a home. Suzanne used her childhood home in the Florida Keys as an example. Her father purchased the house in the early 1970s for $100,000; today it’s worth roughly $1 million because it’s on a canal.

If her father were to give Suzanne the house now and she decided to sell it, she would have to pay taxes on the $900,000 gain. If she inherits it, however, her cost basis is the fair market value at the time she receives the house ($1 million). This adjusted value is called step-up basis. If the house sold for $1 million, Suzanne would have no taxable gain on the sale of the home and any gain or loss would be based on what it was sold for vs. $1 million.

“The reason why is because if that asset is part of my father’s taxable estate, he might be paying 40% tax on an estate tax transfer. And so the idea is that you paid the wealth transfer tax, and now the heirs inherited at the fair market value,” said Suzanne. “Estate taxes are paid on fair market value, not at cost basis. That’s the theory behind the step-up on basis.”

“The times, they are a changin’…”

The Fiscal Year 2024 budget proposal from the Biden Administration contains numerous proposals for changes to the current estate and gift tax environment. That said, don’t wait until legislation is passed or enacted to start planning for change. Talk with your real estate CPA about your estate and trust options, and keep in contact to hear about developing news.

“If you wait until the last possible second and then try to do something, you may find yourself out of luck,” said John. “I don’t believe the stakes have ever been higher, and the changes have never been this sweeping. So it’s a big deal.

“The people thinking through these things and doing this all in advance (will) react and adapt and navigate this environment better.”

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