Estate Planning for Landowners

Robert A. Tufts, Ph.D., J.D. LLM (tax) Alabama Cooperative Extension System

Auburn University tuftsra@auburn.edu

(334) 734-2120

Landowner Concerns

Landowners want to generate income from their property while protecting it for future generations

Two barriers they encounter to meeting their objectives are: Estate taxes and

Fragmentation of ownership when passed to the next generation If a father owned a 500-acre working farm and gave it

equally to his five sons and those five sons gave equally to their five sons, in two generations the 500-acre farm would be reduced to 25 20-acre parcels

Estate Taxes

American Taxpayer Relief Act of 2012 Reunified gift and estate taxes

$5,000,000 applicable exclusion amount made permanent and adjusted for inflation $5,450,000 for 2016

40% maximum tax rate

Portability made permanent

Basis step-up for transfers at death

Portability

Portability is the opportunity for the surviving spouse to use a deceased spouse’s unused applicable exclusion amount (Deceased Spousal Unused Exclusion) For 2016 each spouse has an applicable exclusion

amount of $5,450,000; so, a couple could transfer $10,900,000 to the next generation without taxes Reduces the need for the credit shelter trust and dividing

asset in estate planning

Estate-freeze issues

Estate Tax Planning

Estate tax planning is essentially a gifting program where assets are transferred to the younger generation for no or reduced taxes

Benefit of lifetime transfers Removes income and appreciation

Effective gift tax rate is lower (rate is the same but the base is different) Gifts are tax exclusive

Estates are tax inclusive

Estate Planning

First, use tax-free gifts to the extent possible Medical and tuition

Second, use annual exclusion gifts §2503(b) $14,000 per donee per year

Third, make gifts up to the available applicable exclusion amount (since gifting removes income and appreciation) Transfer life insurance first

Use split-interest gifts (QPRT’s, GRAT’s etc.) or gifts that qualify for a discount (minority interests in a business entity)

Preventing Fragmentation with a Business Entity or Trust

Management of the family farm is a typical problem for second- and third-generation owners

Parents typically leave undivided interests rather than having property surveyed and divided (to my children in substantially equal shares, per stirpes)

As the number of owners increases it becomes difficult to agree on management objectives

Partition is the only remedy when joint owners cannot agree

Co-ownership of property

Two or more persons own the same property at the same time Tenants in common

Each tenant’s interest is alienable, inheritable, and devisable

Joint tenants with right of survivorship A joint tenancy is not inheritable or devisable

A joint tenancy is severed if one of the joint owners transfers her interest during her lifetime

Each owns the right to possess the entire property (Undivided interest)

Joint Management

Commonly owned property is managed jointly by the cotenants. This does not mean that each one must participate in management but only that each has an equal right to manage or control how the property is used.

Any disputes must be worked out among the owners (not the court)

If the cotenants cannot agree on management, the remedy is partition

Partition

Owners may voluntarily partition the property by dividing it physically or selling it and sharing the proceeds

Partition of land between joint owners or tenants in common is a matter of right, but the alternative right to have land sold for division is statutory, and is conditioned upon averment and proof that the property cannot be equitable divided or partitioned among them

Preventing Fragmentation with a Business Entity or Trust

•A trust or business entity can be used to benefit children equally while vesting the management in one or two individuals, e.g. parents

Business Entities in Alabama

Single Owner Sole proprietor

Limited liability company

Corporation, S or C

Business trust

Multiple Owners General partnership

Registered limited liability partnership

Limited partnership

Limited liability limited partnership

Limited liability company

Corporation, S or C

Cooperative

Business trust

Real estate investment trust

Which business entity should you choose?

It would depend on which characteristic is most important to you Limited liability

Participation in management

Transferability of interest

Financial rights

Creditor protection

Liability of Owners

GP/RLLP LP/LLLP LLC Corp.

All partners are liable jointly and severally for all obligations of the partnership A partner in an RLLP is not personally liable

General partners are jointly and severally liable for the debts of the LP Limited partners are not personally liable The GP’s in an LLLP are not personally liable

Members are not liable for obligations of the LLC for acts or omissions of any other member A member may become liable because of his own conduct.

A shareholder is not personally liable for the acts or debts of the corporation (except amount contributed) “Piercing the corporate veil”

Desirable Characteristics of the LLC and LLLP

Maintain control while giving interests to family members (unity of management) Avoids veto power of small owners

Owners can transfer income interest but not management rights

Prevent interests in family property from passing to outsiders as a result of death, divorce or other disposition Creditor/asset protection

Limited liability Limited withdrawal rights

Desirable Characteristics of the LLC and LLLP

Discounted values for entity interests No taxation at the entity level Facilitating gifts Perpetual life Avoids the difficulties with fractional interests Avoids ancillary probate Can be used to reduce estate taxes Provides a succession plan

Disadvantage of the LLC or LLLP When the parents can no longer manage the

business (age, infirmity or death) the younger generation will assume control

Once the next generation controls the business they can dissolve it (requires a super majority)

Trust

An agreement between a grantor and trustee that sets management and distribution criteria Grantor funds the trust

Trustee has legal title to the assets

Assets are held for beneficiaries who have equitable title but not legal title or management rights

Trusts can be Revocable or Irrevocable and

Living or testamentary

Trust

Trustee can be any competent individual, such as an attorney, accountant or even beneficiaries Can use a “corporate” trustee (bank trust department)

Successor trustees are identified to continue management of the assets after the grantor’s death

Successor trustees have to abide by the distribution criteria of the trust, e.g. if the trust does not allow the sale of the family farm, then it cannot be sold by the successor trustees or the beneficiaries

Trust

The life of the trust is governed by the state’s rule against perpetuities Traditional rule was that an interest must vest within a

life in being plus 21 years

In Alabama, a trust that holds real property and allows the trustee to sell property can last for 360 years (100 years if no real property)

Several states have abolished the rule against perpetuities; so, a trust in those state could have perpetual life

Trust

The trust would have many of the advantages of a business entity, such as limited liability, creditor protection, succession plan, etc.

Once the grantor loses competence, the trust becomes irrevocable meaning that there is no flexibility to change the distribution plan

Revocable Trust Instead of a Will Trusts provide greater control over distributions,

e.g. conditions and length of time There can be more than one class of beneficiaries

Privacy concerns – wills are public documents trusts are not

Avoid the expense and trouble of court-supervised proceedings

Property management in case of incapacity

Revocable Trust Instead of a Will Protects residual beneficiaries Creditors Spousal election Only disposes of assets in the trust Statute of limitations is longer – 2 years v. 6 months

Conclusion

With a little planning it should be possible to save the family land Tax planning can save all but the largest land holdings

A business entity or trust can provide a long-term management plan and prevent the land from being subdivided

A will, power of attorney and advance directive are also part of the estate plan