The Sum of the Parts does not always Equal the Whole

Under current estate and gift tax rules, every taxpayer has the ability to give away $5 million of property during lifetime or at death.  With the Bush administration tax cuts set to sunset at the end of 2012, the $5 million exemption could be reduced to as low as $1 million.  Thus, any method of maximizing current gifts could prove to be very beneficial.

The gift tax value of portions of real estate may be substantially less than the gift tax value of the whole because of the ability to value minority interests in real estate at a discount due to lack of control and lack of marketability.  A parents’ ownership of real estate can be converted to a minority interest by gifting undivided minority interests in the real estate to a spouse and children, thereby reducing the one’s own interest to less than 50%.  If the property is owned in an LLC or corporation, gifts of the interests in the entity can be made until the parent’s ownership is less than 50%.  Gifts of undivided interests in real estate often produce discounts of 15% to 25%. The use of an entity to facilitate the transfers may actually increase the discounts to between 25% and 35% or more, depending on the nature of the underlying real estate and the restrictions contained in underlying document.

The tax benefits from this type of planning can be significant. Assume a parent owns 100% of an LLC that owns real estate.  If the property is worth $2 million and the parent leaves it to his children at death, assuming a 50% estate tax rate, the transfer tax cost would be $1,000,000.  If, instead, the parent gifted minority interests to his children to reduce his/her interest in the LLC to 40%, all of the interests, including the retained interest, would be discounted by up to 35%, thereby reducing the value of the transferred property to $1.3 million and reducing transfer taxes to $650,000, a $350,000 savings.  If the gifting program were accomplished over a period of years using annual gift tax exclusions (currently $13,000 per donee, per year), the tax savings would be even greater.

Opportunities abound for gift and estate tax savings for owners of real estate.  Please contact Jeff Newman or call your ORBA advisor at 312.670.7444 so we can prove to you that the sum of the parts can be greater than the whole.