Long-Term Leases Substantially Reduce Estate Tax

Posted on August 12, 2011 by Bryan Howard

In a recent case decided by the Tax Court, Estate of James L. Mitchell v. Commissioner, T.C.M. 2011-94, the Tax Court determined that the long-term leases on a ranch and home owned by the decedent significantly reduced the values of the properties. The home was subject to a 20-year lease. The value of the home without a lease was $14 million. The court determined that the value of the property subject to the lease was $6 million. This represents a 57% discount attributable to the lease.

The ranch was subject to a 25-year lease. The value of the ranch without a lease was $13 million. The value of the ranch with the lease was $3.37. This represents a 74% discount due to the lease.

One might think that the lease payments were below market. However, evidence presented at trial indicated that the rent charged with respect to both properties reflected market value. The significant decrease in value is attributable to the way properties subject to a long-term lease are valued. Appraisers value the stream of rental income payments plus the value that you could sell the property for after the lease term is over. This stream of payments is discounted by the rate of return that an investor would require to take over the stream of payments. Often, the discounted value of the stream of payments is lower than the value that you could sell the property for if the property did not have a lease.

The properties owned by Mr. Mitchell were somewhat unusual. A more typical circumstance is real estate leased to a family business. You should consider leasing the property for a long-term. 

After a long-term lease is entered into with respect to a property, you should consider some type of gifting transaction. Rental real estate works well for a direct gift, a GRAT, or an installment sale to a grantor trust.

In summary, if you have rental real estate that you intend for you and your family to own for several years, you should consider leasing the property for a long term. The lease can significantly reduce estate taxes upon your death.
 

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Estate Planning for Second Marriages

Posted on August 16, 2010 by Bryan Howard

I came across an interesting article regarding estate planning for second marriages. The article highlights some of the most common issues faced by male business owners who have children from a prior marriage. Women, of course, face many of the same issues.

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CRS Report Says Estate Tax Not a Widespread Problem for Farms and Family Business

Posted on December 8, 2009 by Bryan Howard

The Congressional Research Service (“CRS”) has issued a report titled “Estate and Gift Taxes: Economic Issues.” The CRS is a “think tank” that provides reports to members of Congress on a variety of topics. Taxpayers spend over $80 million per year to fund the CRS. One controversial conclusion of the report is that

“…Only a tiny fraction of farms and small businesses face the estate and gift tax and it has been estimated that the majority of those who do have sufficient non-business assets to pay the tax. Moreover, only a small portion of the estate tax is collected from these family owned farms and small businesses, so that dramatically reducing estate tax rates or eliminating the tax for the purpose of helping these family businesses is not very target efficient.”

This report is supposedly based upon data from estate tax returns that have been filed. However, the conclusions drawn in the report are not realistic.

A lot of my clients have farms and small businesses. These clients worry a great deal about estate taxes. They purchase large life insurance policies to provide funds to be used to pay taxes. They establish and fund irrevocable trusts and various entities including limited liability companies and/or limited partnerships. They make gifts and sales to trusts for their children sooner than they would prefer if there were no estate taxes.

As mentioned in the report, some families are able to accumulate enough liquidity outside the business to pay taxes. In some cases, this means that the only asset left to pass on to children is the family business. When one or more children do not work in the business and cannot draw a salary from the business, this is not a happy result.

Perhaps my view is distorted because of the region in which I practice. Middle Tennessee probably has more valuable farmland than other areas of the country. The value is not necessarily based on the value of the land for farming. In many cases, the value of the farmland is artificially inflated by the development potential of the property.

Middle Tennessee also has a keen entrepreneurial spirit. I am constantly amazed by the ingenuity of my clients and how they have amassed a fortune from one or more business opportunities.

Nevertheless, the notion that reducing taxes on family businesses is not worthwhile clearly misses the mark. Owners of farms and successful family businesses spend a lot of time and money on planning strategies to cope with the liquidity crunch and distortions to their estate plan that are caused by estate taxes.

Members of the House of Representatives were not fooled by the Report. They understand that estate taxes create severe problems for owners of farms and family businesses. On December 3, 2009, they passed the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009. Though this bill does not eliminate estate taxes, it seeks to ensure that married couples will be able to leave up to $7 million to their children without paying federal estate taxes. This bill has been forwarded to the Senate, where it faces an uncertain fate.
 

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