In an uncertain market, many wealthy clients are fearful of giving away liquid assets to reduce the size of their estates. An alternative is to give a home to the next generation using a lease-back strategy.
This is according to Chicago based planner and attorney Michael Passananti of Duggan Bertsch, who says paying market rate rent into a grantor trust can be a good way to gradually reduce the size of an estate over time. This is especially so at a time when rents are high and property values remain relatively low, he thinks.
"The real play is moving an asset that's potentially a valuable asset plus any growth in that asset out of your estate," Passananti says.
It works for clients with a number of characteristics, he adds. They must have a highly taxable estate and the desire to hang onto their investment portfolio. The residence in question must be fully paid off. And the clients must have the cash flow and reserves to make the rental payments.
"Maybe the first requirement," Passananti says, "is a client who is emotionally ready to lose their home. I have clients who say, 'I have $10 million in cash. What if the market drops by half and I have $5 million? I'm sorry, Mike, I am not gifting away my home.' Others are like, 'This is my home. It's the American dream.' It's emotional and the emotions can inhibit the transaction.'"
The tactic did work, he says, for clients in their 50s who know their estate will face high taxes. They gifted away a mountain vacation home, which had dropped precipitously in value. As the vacation area begins to rebound, they decided to gift the property to a grantor trust and to begin making lease payments into that trust as well, Passananti says.
"They are essentially making lease payments to themselves in a tax-free transaction," he says and reducing their estate size over time. "This was an awesome, great move because this client has a highly taxable estate."
For clients who gift a property and make lease payments directly to heirs, the strategy works when the next generation is in a lower tax bracket than the anticipated tax on the estate.
"Then what you have is a positive tax arbitrage," he says.