So you spent your entire life building your business and real estate empire. It has afforded you and your family a world class lifestyle.
Vacations to the Caribbean, a beach house in Miami, sports cars, a private school education for your children, and so much more.
However, you know that one day, it will be time to pass it all on to the next generation. But to do so you will have to bob and weave through gift and estate taxes that will eat away at the wealth you have built over the years.
Not to mention the operational hurdles that come with passing your business and real estate on to the next generation.
The good news is, the earlier you plan for this event, the more options you will have when it comes to protecting your wealth from these pitfalls.
Gift and Estate Taxes
Thanks to the Tax Cuts and Jobs Act, the gift and estate tax exemption has increased to $11,200,000 for individuals and $22,400,000 for married couples.
This means you can pass down up to $22,400,000 to the next generation without paying the gift and estate tax, which can be up to 40%. (Uncle Sam gets you coming, and he gets you going.)
For those with estates worth less than $22,400,000 this is great because you won’t have to worry about getting too complicated with your estate planning.
Plus, if you have utilized 1031 exchanges over your lifetime, you can pass down your real estate directly to your heirs, and they will receive it at what’s called a stepped-up basis, which is the fair market value at the date of your death. This will eliminate all the deferred tax that has been accumulated throughout your lifetime.
So you’re a big baller and you’re pretty sure that your estate will be worth more than $22,400,000 by the time of your death.
I know you’re not ready to just lay down and pay Uncle Sam up to 40% after you already paid a bunch of taxes as you were building your empire.
That’s where irrevocable trusts come into play. Irrevocable trusts allow you to gift a business or asset to the trust at its current basis.
The benefit of this strategy is your real estate can continue to appreciate outside of your estate, and won’t be added to your gift and estate tax exemption. The downside to this is, the basis in the property will be at the date the property is transferred to the trust. This can cause your heirs to be subject to significant capital gains tax at the time of sale.
Also, irrevocable trusts allow your heirs to skip the probate process after your death as the trust will not be part of your estate and it will avoid someone out of your control managing your assets.
You gift a property with a basis of $1,000,000 to an irrevocable trust in the year 2020. The $1,000,000 is counted toward your gift and estate exemption.
By 2062 the asset has appreciated to $2,100,000 and you pass away. The $1,100,000 in appreciation is not included as part of your estate. However, should your heirs decide to sell the property, they will have to pay capital gains taxes on $1,100,000 as they received it at the basis of $1,000,000 when it was transferred to the trust.
Control of the Assets
So you successfully planned to pass down your wealth to your heirs with minimal exposure to the gift and estate tax, but who is going to run your business or manage these assets?
A good place to start is by grooming your heirs to take over the responsibility. This can start early on in their lives by being open about the family’s financial affairs and beginning to include your children in your business at an early age.
However in some cases your heirs may not be up for this task. If this is the case, you will want to start building a team to take over and run your business or manage your assets once you’re no longer able to.
In addition, you can use trusts and appoint a trustee(s) to manage the assets, and administer the wealth to your heirs as you see fit.
The Bottom Line
Passing down the wealth you accumulated over your lifetime will take much planning and forethought. It will include planning on both the tax and legal side of things, as well as the operational side.
And the earlier you can start this process, the more options you will have at your disposal. You can begin today by discussing this process with your both your heirs, as well as your tax and legal advisors.