Estate planning is an essential aspect of financial planning that often goes overlooked by commercial real estate owners. While most individuals are familiar with estate planning for personal assets such as houses and cars, it is equally important to consider the disposition of businesses in the event of death. Without a clear succession plan in place, disputes and complications can arise, potentially jeopardizing the future of the business. In this comprehensive guide, we will explore the key elements of estate planning for commercial real estate owners, including post-mortem goals, liquidity, estate tax deferral, dealing with lenders, control and continuity, and tax mitigation strategies.
Post-Mortem Goals of a Successful Commercial Real Estate Investor or Developer
Commercial real estate investors and developers have specific goals when it comes to estate planning. These goals include:
- Orderly and efficient post-mortem administration of assets: A well-structured estate plan ensures that the transfer of assets is smooth and organized, minimizing delays and complications.
- Business continuity: It is crucial to plan for the seamless continuation of the business after the owner’s death, ensuring its long-term success.
- Maintaining control for the family: Estate planning should ensure that the owner’s family maintains the same degree of control over the business as the owner did during their lifetime.
- Deferring and minimizing death taxes: Estate taxes can be a significant burden, but proper planning can help defer and minimize these taxes, allowing more assets to pass to the owner’s family.
- Providing necessary liquidity: Liquidity is essential to address post-mortem cash needs, including potential estate taxes. Adequate planning ensures that there are sufficient funds available to meet these obligations.
- Addressing existing creditor and lender relationships: Estate planning should account for existing loans, mortgages, and other financial obligations to ensure a smooth transition without triggering default or financial strain.
Liquidity in Estate Planning
One of the critical considerations in estate planning is liquidity. It is essential to have sufficient funds available to support the owner’s spouse, children, and address any immediate cash needs that may arise after the owner’s death. Liquidity is particularly crucial when it comes to paying estate taxes, which are typically due within nine months of the decedent’s death.
To ensure adequate liquidity, consider the following strategies:
- Additional authorized signatories: Ensure that each business checking account has an additional authorized signatory to prevent delays in accessing funds in the event of the owner’s death.
- Review life insurance policies: Evaluate existing life insurance policies to determine if they provide sufficient liquidity for the business and estate. Consider using an irrevocable life insurance trust (ILIT) to shield the proceeds from estate taxes and meet liquidity needs.
- Buy-sell agreements: Implement buy-sell agreements with business partners to address the transfer of ownership in the event of a partner’s death. This can help ensure a smooth transition and provide liquidity for the deceased partner’s estate.
- Review entity organizational documents: If the business is owned by an entity with multiple partners or owners, review the organizational documents to determine if there are provisions for the sale or refinancing of the business interest upon the death of a partner/owner.
- Delayed funding of specific cash bequests: Include language in the estate plan that allows for the delayed funding of specific cash bequests until the estate’s cash needs are met.
- Retain control over a management company: Ensure that the estate retains control over a management company that can provide a steady cash flow to the family following the owner’s death. Consider gifting or bequeathing the management company to maintain this source of liquidity.
Section 6166 Estate Tax Deferral
Section 6166 of the Internal Revenue Code allows for the deferral of estate taxes attributable to business interests over a period of up to 14 years at reduced interest rates. This provision can provide the estate with sufficient time to dispose of illiquid assets or raise cash without resorting to fire sales. However, qualifying for this tax relief requires careful planning and adherence to specific requirements.
To take advantage of Section 6166 estate tax deferral, consult with a knowledgeable estate planning professional who can guide you through the technicalities and help structure your estate plan accordingly.
Dealing with Lenders in Estate Planning
Existing loans and mortgages can present challenges in the estate planning process. The death of a key principal or guarantor can trigger an “event of default” under loan agreements, allowing lenders to exert financial pressure on the deceased owner’s estate.
To mitigate these risks, consider the following strategies:
- Substitution of guarantor: Review existing loan agreements to determine if they allow for the substitution of a separate entity guarantor following the death of an individual guarantor. Negotiate loan terms that provide flexibility upon death and explore the possibility of funding an entity with sufficient liquidity to serve as a guarantor.
- Flexibility in future loan agreements: When negotiating loan terms for future developments, structure guaranties that allow for maximum flexibility in the event of a guarantor’s death. This can help prevent default and financial strain on the estate.
Control and Continuity in Estate Planning
Maintaining control and ensuring continuity of the business are essential goals in estate planning for commercial real estate owners. Joint venture, limited partnership, and operating agreements should be carefully reviewed to address control provisions and potential changes in ownership.
Consider the following strategies:
- Successor general partner or manager: Provide for a named successor in joint venture or partnership agreements to ensure continuity of management and control in the event of the owner’s death.
- Management succession planning: Plan for management succession by identifying individuals or fiduciaries who can effectively run the real estate business after the owner’s involvement ceases.
- Review control provisions: Review agreements to determine if partners or other parties have the ability to take control of the property upon the owner’s death. Consider provisions that protect the interests of the owner’s family and ensure continued cash flow to support them.
Tax Mitigation Strategies in Estate Planning
Effective tax planning is a crucial aspect of estate planning for commercial real estate owners. Consider the following strategies to mitigate tax consequences:
- Lifetime transfers of non-controlling interests: Craft partnership and entity operating agreements that permit lifetime transfers of non-controlling interests to family members. Structuring these transfers properly can result in substantial discounts for gift tax purposes.
- Utilize annual exclusion gifts: Take advantage of the annual exclusion gifts, which allow for tax-free transfers of up to $15,000 per donee ($30,000 for married couples). Trusts can be used to consolidate these transfers and provide equal treatment for each donor’s children.
- Reduce estate tax value of retained non-controlling interests: Consider relinquishing a controlling interest in the business to reduce the estate tax value of retained non-controlling interests. This strategy involves non-tax considerations and should be evaluated carefully.
- Retain control through trusts: Make transfers to trusts that allow the donor to retain some degree of control over the transferred interests while removing them from the estate.
- Use of grantor trusts: Utilize grantor trusts to transfer assets while retaining the ability to pay income tax liability associated with the transferred interest. This strategy allows for tax-free growth of trust assets and the ability to claim tax losses.
- Spousal Lifetime Access Trusts (SLATs): Establish SLATs to remove assets from the estate while providing the donor’s spouse with ongoing access to the assets if needed.
- Freeze the value of the estate: Consider techniques such as grantor-retained annuity trusts (GRATs), installment sales, and partnership freezes to freeze the value of the estate and reduce estate tax liability.
- Consider Section 754 election: Explore the election under Code Section 754, which allows for the adjustment of the basis of partnership property upon distribution or transfer of partnership interests.
Estate planning is a critical component of financial planning for commercial real estate owners. By considering post-mortem goals, ensuring liquidity, deferring estate taxes, addressing lender relationships, maintaining control and continuity, and implementing tax mitigation strategies, owners can protect their businesses and provide for their families. Consult with an experienced estate planning attorney to develop a comprehensive estate plan that addresses the unique needs of your commercial real estate holdings. With proper planning, you can secure the future of your business and leave a lasting legacy for your loved ones.
About Estevez Law Group, P.A.
Helping clients with real estate, commercial real estate transactions, residential property purchases and sales, estate planning, and more! Skillful legal representation can simplify complex real estate transactions and solve problems that frustrate all parties involved. At the Estevez Law Group, P.A. our boutique real estate law firm and title agency assists clients with all types of residential and commercial property matters.
> Learn More