The sale to an IDGT produces results similar to a GRAT, but has several advantages: (i) the interest rate that the asset must outperform is generally less than that of a GRAT; (ii) the grantor need not survive the term of the trust for the transaction to be successful; (iii) GST exemption may be allocated to the trust on its creation; and (iv) the sale does not constitute a taxable gift. Any income earned by the trust is taxed to the grantor. This further magnifies the gift to the grantor’s descendants, because the growth in the value of the property in the trust belongs to the next generation while any income tax generated on it is paid by the grantor. 

Real Estate Holding Businesses

Instead of holding real estate through an entity, many family businesses own income-producing real estate directly. When limiting liability through use of  an entity (such as a limited liability company) is not a concern, the GRAT and sale to an IDGT can be used to transfer interests in the real estate to the next generation.

For management of  the real estate after transfer of interests to the next generation, the family owners should consider entering into a tenancy-in-common agreement. Such agreements typically address who manages the property, how capital calls should be handled, and when distributions of income should be made, among other issues. They can also include restrictions on transferring interests in the real estate to non-family members and assurances that family members can compel the purchase of their interests if they need liquidity.

Leveraging With Discounts

Many of these gifting techniques involve the intra-family transfer of a partial interest in the business. One benefit of partial-interest transfers is the well-accepted practice of discounting the value of the transfer based on the lack of marketability of the transferred interests and lack of control of the business. These discounts result in reducing the full pro-rata value of the transferred interest (after all, who would pay the full pro-rata value for an interest in a family business that is difficult to sell or in which the minority owner has no control over the business?). For gifting purposes, discounts reduce the amount of gift tax exclusion used on the transfer. For sale purposes, they reduce the overall purchase price of the interest (thereby reducing both the amount of the required interest payments to the grantor and the risk that the asset will not appreciate at a rate that exceeds the debt service on the promissory note).

However, proposed IRS regulations released August 2, 2016, seek to limit the availability of these discounts for family-owned businesses.  If adopted without change, these proposed regulations would significantly reduce, and perhaps eliminate, valuation discounts for intra-family transfers of partial interests in businesses. That would increase the transfer tax associated with certain transfers. At this point, the regulations are still in draft form, but it is possible that the regulations will become effective as early as the first quarter of 2017. Anyone considering a transfer of a family-owned business under the current rules should consider completing the transfer promptly.

Jeffery B. Levi and M. Brooke Wilson are partners in the Trusts & Estate Practice Group at the Oakland, California-based law firm Wendel, Rosen, Black & Dean LLP. They may be reached at (510) 834-6600 or [email protected] or [email protected]

First « 1 2 » Next