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

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slide1

Schwabe, Williamson & Wyatt’s

Real Estate and Business Seminar Series

Tax Saving Strategies for

Apartment Building Owners

March 8, 2006

Seattle, WA

important notice
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.

slide3

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
slide6

Overview of Current Tax Regime

Washington State Estate Tax

slide7

Jake

Julie

Mary

David

Mark

Jennifer

Jason

Justin

Eva

Alex

Emma

Claire

Harry and Sally’s Family Tree

Harry

Sally

slide9

Harry Dies

Harry’s

Share

$5 Million

Sally’s

Share

$5 Million

Simple Will

Sally Dies

Sally’s

Estate

$10 Million

Case #1

No Tax Planning (Simple Wills)

Harry and Sally’s

Estate

$10 Million

(all subject to taxes)

slide10

Harry Dies

Harry’s

Share

$5 Million

Sally’s

Share

$5 Million

Fed Credit

Shelter

$1.5 Mil

State Credit

Shelter Trust

$2 Mil

Marital Trust

$1.5 Mil

Sally Dies

1/3

Jake’s

Share

1/3

Jennifer’s

Share

1/3

Julie’s

Share

Case #2

Basic Estate Tax Planning

Harry and Sally’s

Estate

$10 Million

slide11

Case #2

Basic Estate Tax Planning

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
slide12

Harry

50%

Sally

50%

Apartment A, LLC

Case #3

Family LLC Structure

Member and

Co-Manager

Member and

Co-Manager

case 3 discounts of llc interests
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”
slide14

Sally

50%

Harry

50%

Apartment A, LLC

Apartment A

$3 Million

Owned by Harry and

Sally Jointly

Case #3

Family LLC Strategy

Discounted Value @ 35%

$1,950,000

All three apartments

Total: $9 million

All three LLCs

Total: $5,850,000

slide16

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?
slide17

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?
slide18

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!
slide19

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
slide20

Children and Spouses

Up to $12,000 each per year

Grandchildren’s Trusts

Up to $12,000 per year, per beneficiary

Sally

50%

Harry

50%

Apartment A, LLC

Case #4

Family LLC With Gifting Program

slide21

Case #4

Year 1 Gifts

slide22

Case #4

Year 4 Gifts

slide23

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
slide24

$195,000 / yr

To H & S

Jennifer

33%

Sally

50%

Harry

50%

Jake

33%

Julie

33%

Apartment B, LLC

Apartment B, LLC

GRAT

10 Years

Value:

$1,950,000

Value:

$ 3,570,000

Case #5

Grantor Retained Annuity Trust (GRAT)

Gift tax exemption used:

$1,070,000

slide25

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
slide26

Note to H & S

$110,000 / yr

Sally

50%

Harry

50%

Jennifer

33%

Jake

33%

Julie

33%

Apartment C, LLC

Apartment C, LLC

IDIT

Sale

60%

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
slide27

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
slide28

Schwabe, Williamson & Wyatt’s

Real Estate and Business Seminar Series

Questions?

Thank you.

about the presenters
Dennis A. Ostgardis 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.

About the Presenters