structuring preferred partnership freezes in estate...
TRANSCRIPT
Structuring Preferred Partnership Freezes in
Estate Planning: Navigating IRC Chapter 14
Valuation Rules
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TUESDAY, APRIL 2, 2019
Presenting a live 90-minute webinar with interactive Q&A
Andrew L. Baron, Counsel, Meltzer Lippe Goldstein & Breitstone, Mineola, N.Y.
Stephen M. Breitstone, Partner, Meltzer Lippe Goldstein & Breitstone, Mineola, N.Y.
Lawrence J. (Larry) Macklin, Managing Director & Wealth Strategies Advisor,
Bank of America Private Bank, Baltimore
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STRUCTURING PREFERRED PARTNERSHIP FREEZES IN ESTATE PLANNING
Strafford Webinar
April 2, 2019
Larry MacklinBank of America Private BankManaging Director, Wealth StrategistBaltimore, [email protected]
IMPORTANT: This presentation is designed to provide general information aboutideas and strategies. It is for discussion purposes only since the availability andeffectiveness of any strategy are dependent upon your individual facts andcircumstances.
Neither Bank of America Private Bank nor any of its affiliates or advisors providelegal, tax or accounting advice. Clients should always consult with their independentattorney, tax advisor, investment manager, and insurance agent for finalrecommendations and before changing or implementing any financial, tax, or estateplanning strategy.
Bank of America Private Bank operates through Bank of America, N.A., and othersubsidiaries of Bank of America Corporation. Bank of America, N.A., Member FDIC.
© 2019 Bank of America Corporation. All rights reserved. | 0419LMA|
DISCLOSURE
6
INTRODUCTION
Traditional Trust Based Freeze Estate Planning
• Grantor Retained Annuity Trust (GRAT)
• Sale to a Grantor Trust for a Promissory Note (a/k/a Sale to an Intentionally Defective Grantor Trust (SIDGT))
7
GRAT AND SIDGT
• Two of the most common estate planning techniques
• Both provide a freeze in the value of the grantor’s estate
• Both depend on the use of an Irrevocable Grantor Trust
• The income within a Grantor Trust is taxed to the Grantor whether or not the income is retained within the trust or distributed to the beneficiary
• A Grantor and his/her Grantor Trust cannot have an income tax transaction between them as they are treated as one income taxpayer
8
GRANTOR RETAINED ANNUITY TRUST (GRAT)Overview
• A GRAT is a strategy that allows transfer of all appreciation above a discount rate set by IRS to family beneficiaries over a period of time
• Provides for income stream to grantor (annuity payments in cash or in kind) over a specified number of years
• Requires that the grantor survives the term of the GRAT, or, generally, the full market value of trust property is included in the estate of the grantor
• Serial GRATs with staggered maturities can be used to mitigate risk of death during the term of a single GRAT
Tax Benefits
• The retention of an annuity stream by the grantor reduces the value of the gift; the GRAT can be structured to provide for zero gift at inception
• A GRAT is most beneficial when funded with an asset that is expected to appreciate significantly
• Transfer of the assets to the trust does not create an income tax event
• Freezes value of assets in owner’s estate at time of transfer and gives beneficiaries almost all of the upside benefit of appreciation
9
GRANTOR RETAINED ANNUITY TRUST (GRAT)Mechanics
1) Assets are placed into an irrevocable trust for a fixed term
2) Fixed or variable annuity is paid to grantor during term of the trust
3) At the expiration of the trust term, the remaining assets are passed to beneficiaries or to a trust for the benefit of the beneficiaries
Owner
Beneficiaries
Remainder at Expiration
GRAT
3
Transfer of Assets
Annuity Payment
1
2
10
GRANTOR RETAINED ANNUITY TRUST (GRAT)
If $1,000,000 is transferred to a GRAT . . .
#1#2#3#4#5#6
(1) Term3 years
10 years3 years
10 years3 years
10 years
(2) Annual Payment$100,000/year$100,000/year$346,753/year$111,326/year$374,111/year$135,867/year
(3) §7520 rate2.0%2.0%2.0%2.0%6.0%6.0%
Value of Retained Annuity
$288,390$898,260
$1,000,000$1,000,000$1,000,000$1,000,000
Taxable Gift$711,610$101,740
$0$0$0$0
KEY OBSERVATIONS
• #1 & #2 - Notice how the amount of the taxable gift is smaller as the annuity term is extended.
• #3 & #4 – These are “zero-ed out” GRATs - the annuity payments are increased so the value of the retained annuity almost exactly matches the amount of the transfer to the trust.
•#5 & #6 – These are also “zero-ed out” GRATs – however, because the §7520 rate increased, grantor will need to select a higher annual payment in order to “zero-out” the taxable gift. This results in less dollar value being left in the trust for the remainder beneficiaries after the expiration of the GRAT term.
11
SALE TO A GRANTOR TRUST FOR A PROMISSORY NOTE
Overview
• Sale to an Intentionally Defective Grantor Trust (SIDGT) is a strategy that transfers future appreciation above an “inter-family loan rate” to family beneficiaries
• Assets are sold by the owner (not gifted) to the trust in exchange for an interest bearing promissory note
Tax Benefits
• Sale to trust of assets does not generate income tax: Trust is structured as an intentionally “defective” grantor trust so that owner continues to be responsible for income taxes but transfer is considered a completed gift for gift/estate tax purposes
• Grantor remains responsible for all income tax on income earned by trust and income tax paid by grantor does not constitute additional gift to beneficiaries
• Freezes value of assets in owner’s estate at time of transfer and gives beneficiaries almost all of the upside benefit of appreciation
12
SALE TO A GRANTOR TRUST FOR A PROMISSORY NOTE
Mechanics
1) Grantor establishes trust; “seeds” trust with gift of cash or assets
2) Grantor sells assets to trust for a promissory note with “intra-family interest rate”
3) Interest and principal on note is paid on current or accrued basis
4) Excess value over note principal/interest remains in trust for beneficiary at the end of the note term with no gift tax due; only value included in owner’s estate is the value of the promissory note
Owner
Interest Bearing Note
Excess Value over Note Principal remains in Trust for Beneficiary
DefectiveGrantorTrust
Sale of shares
2
3
4
Establish trust with gift
1
13
COMPARING A GRAT VS. SIDGT
GRAT SIDGT
Authority StatutoryThough well established, tax statutes do not create SIDGTs. A combination and interpretation of statutes yields this strategy
Strategy’s success requires assets to outperform IRS’
hurdle rate
IRS hurdle rate is §7520 rate (i.e., 120% of mid-term AFR) in effect when GRAT created
IRS hurdle rate will always be lower than §7520 rate if SIDGT’s term is 9 years or less
GST PlanningGrantor cannot allocate GST Tax Exemption to GRAT while Grantor is receiving annuity payments
Grantor can allocate GST Tax Exemption to “seed gift” to make SIDGT an exempt GST trust
Ability to stretch out payments
Payment must be made annually and can increase no more than 20% over the previous year’s payment
Can “backload” by using a balloon note where the principal balance is paid during last year of the installment note
Ability to “Zero Out”Can “zero out” by following the approach done in the Walton Tax Court case
Can “zero out” by not making a “seed gift,” though it is considered more aggressive
Death during term:
Estate tax result
Grantor’s Gross Estate will include amount required to produce the annuity using the §7520 rate in effect and grantor’s death
Grantor’s Gross Estate will only include the unpaid principal balance and accrued interest on the note
Death during term: Income tax result
No income tax consequence Some say gain on installment note is triggered as IRD; some say not
14
FORMER PRESIDENT’S PROPOSALS – GRATS AND SIDGTS
• GRATs must have a minimum term of 10 years and a maximum term of the grantor’s life expectancy plus 10 years
• GRAT remainder interests must have a minimum value equal to the greater of 25% of the value of the assets contributed to the GRAT or $500,000
• Prohibits the grantor from engaging in a tax-free exchange of any asset held in a GRAT
• After a transfer to a SIDGT, all future trust investment returns will either be included in the grantor’s estate or be a deemed gift from the grantor
15
GRATS AND SIDGTS UNDER UTILIZED?
• Both use irrevocable trusts
• Both require a third party trustee (after initial GRAT term)
• Grantor loses control
• Grantor loses future access to assets transferred
• Many would be Grantors, especially entrepreneurs, believe that they need to control and have access to as much wealth as possible in the future
16
A LITTLE BIT OF HISTORY
• Prior to 1987, Common Estate Planning included:
– Estate Freeze – Senior transferred future appreciation of business to junior but retained control of the business Recapitalization into voting common, non-voting common, and
preferred stock
Transferred almost all value to non-cumulative preferred stock
Transferred non-voting common with little value to junior
–Grantor Retained Income Trust – Senior transferred property retaining an income interest (typically in non-income producing property) and reduced the gift value reported by a significant, predetermined actuarial value of the income interest
17
A LITTLE BIT OF HISTORY
• The Revenue Act of 1987 attempted to limit this practice by modifying Internal Revenue Code (IRC) Section 2036(c)
• The Revenue Reconciliation Act of 1990 retroactively repealed the 1987 changes and added Chapter 14 (IRC Sections 2701 through 2704)
• These valuation rules remain the hurdles to transfer (estate/gift) planning today
– (Note: Section 2704 Proposed Regulations were withdrawn by the IRS on October 20, 2017)
18
Structuring Preferred Partnership Freezes in Estate Planning
© 2019 Meltzer, Lippe, Goldstein & Breitstone, LLPAll rights reserved.
Stephen M. Breitstone, EsqAndrew L Baron, Esq.
Meltzer, Lippe, Goldstein & Breitstone, LLP [email protected]
STRAFFORD CLE CREDIT SEMINAR
April 2, 2019
Presentation Overview
• Transfer Tax Planning vs. Basis Planning
• Uncertainty with Grantor Trusts
• Section 2701 - Deemed Gift Issues with Preferred and Profits Interests
• Negative Capital – The Issue with Grantor Trusts
• Freeze Partnerships to Maximize Basis Step Up
• Advanced Planning with Freeze Partnerships
• Recent Developments
20
Transfer Tax Planning v. Basis Planning
Lifetime Planning - the Trade Off
• Transfer future appreciating assets out of taxable estate
• No basis step-up
• May not be a good tradeoff – especially with today’s exemptions of $11,180,000 per person (through 2025) as adjusted for inflation (currently $11.4 million per person for 2019).
22
Income Tax And Transfer Tax Illustration
Assets
Real Estate (fmv) $10,000,000
Real Estate (basis) $1,000,000
Liabilities – Mortgage ($8,000,000)
Capital – Equity $2,000,000
Income Tax – Gain on Sale
Real Estate is Sold for $10,000,000
Gain subject to taxation $9,000,000
Tax @ 20% $1,800,000
Tax @ 25% $2,250,000
Tax @ 41.5% Fed, NIIT, State & Local
(NYC)
$3,735,000
Estate Tax
Equity subject to taxation $2,000,000
Tax @ 50% $1,000,000
Transfer tax is on net equity
Income tax is
recourse debt
Income tax is on gain
realized, which includes non-recourse debt
23
Uncertainty with Grantor Trusts
Uncertainty with Installment Sales to Grantor Trusts
Lifetime termination of grantor trust status - tax consequences are well-settled
• The grantor has given up dominion and control, and the trust is now a separate taxable entity.
• Grantor is deemed to have transferred the assets and liabilities in the trust to the trust, for income tax purposes.
• Madorin v. Commr., 84 T.C. 667 (1985). See also Treas. Reg. 1.1001-2(c), Example 5 (1980), Rev. Rul. 77-402, 1977-2 C.B. 222 and TAM 200011005, G.C.M. 37228 (Aug. 23, 1977).
25
Uncertainty with Installment Sales to Grantor Trusts
Death of grantor termination of grantor trust status - Sharp Disagreement
• Gain Triggered on Death of Grantor or Avoided?
• Basis Step-Up?
• Income in Respect of a Decedent?
There is no case, regulation or ruling that directly addresses the income tax treatment.
• Rev. Proc. 2015-37 – No more rulings on step up upon termination of grantor trust status upon death of grantor.
• IRS 2018-2019 Priority Guidance Plan – Guidance on basis of grantor trust assets at death under Sec. 1014
• New Form 1065 check-the-box for negative capital accounts.
Applies to negative capital account balances not otherwise reported on Schedule K-1.
Penalties apply for failure to report.
26
Freeze Partnerships
Advantages
• Negative Capital (liabilities in excess of basis) – gain not triggered
• Basis step-up for frozen interest (including negative capital)
• Statutory guidelines under section 2701
• Section 6166 estate tax deferral
Considerations
• Highest hurdle rate
• Possible section 2701 deemed gift
27
Section 2701 – Deemed Gifts
Introduction to Freeze PartnershipsTwo Classes of Ownership
Preferred Interest
• Periodic cash distribution fixed (or tied to anestablished index) cumulative preferred return
• Liquidation preference - a priority distribution in afixed amount upon liquidation
• Dividend Rate and Liquidation Preference isdetermined at the time of contribution to theentity (or recapitalization)
• The value of that interest is "frozen" as of thatdate
Common Interest
• Cash distributions only if there is any moneyremaining after payment of the preferred return
• Entitled to all of the future increases in the incomefrom underlying assets
• Appreciation in excess of preferred return inuressolely to the common interest holders
Freeze Partnership
Preferred
Interest
Common Interest
EquityJunior EquityEquity
Senior Equity
29
Section 2701
Is there a transfer?
• Gift
• Sale
• Capital contribution
• Reorganization
To or for the benefit of a "member of the family"?
• Generally, of an equal or lower generation
• Treas. Reg. Section 25.2701-1
Did the Transferor (or "applicable family member") retain an "applicable retained interest"?
• Applicable Retained Interest means distribution rights in family controlled entity and liquidation preference; or liquidation, put, call or conversion right
• Applicable Family Member means generally of an equal or higher generation
30
Section 2701 – Zero Value Rule
• If there is a transfer under Section 2701, the retained interest will be valued at zero for gift tax purposes
• Exception: the transferor retains
a "Qualified Payment Right"; or
a liquidation, put, call or conversion right.
31
Exception To Section 2701 Zero Value Rule
Straight Up Allocation Exception to Zero Value Rule
• All membership interests are of the same class
• All allocations are straight up
• Differences in voting rights are permitted
• Differences in liability permitted (e.g., GP v. LP)
• Marketable securities can be of a different class
• Vertical slice for fund managers
32
Section 2701 – Qualified Payment Rights
• Qualified Payment Rights
Periodic (at least annual) cumulative fixed payment rights
Valued according to fair market value (FMV)
• Lower of Rule
If a qualified payment right is held along with an extraordinary payment right the rights are valued as if each was exercised in the manner resulting in the lowest value for all such rights.
• Four Year Rule
Any payment of a qualified payment made (or treated as made) either before or during the four-year period beginning on the due date of the payment but before the date of the taxable event is treated as having been made on the due date.
33
Entity Level Valuation - Family Owned
• The 2701 Regulations promulgated in 1992 provide that all family owned preferred interests are valued as if held by a single person.
• Exception for Capital Contributions. See, Treas. Reg. 25.2701-3(b)(1)(i).
• Contrast Rev. Rul. 93-12 (recognizing intra family valuation discounts).
• Lack of marketability discounts should apply to junior equity interest.
34
Deemed Gift is Determined theSubtraction Method
Step 1 – Entity Value
• Value all family-held interests as if held by one person (except capital contributions)
• Each family member is considered to have the right to liquidate and sell
Step 2 - Subtract the value of senior equity interests
• Value determined as if held by one person (2701)
Maximizes the value of the gift
Step 3 – Step 1 less Step 2
• Allocate the remaining value among the transferred interests and other family-held subordinate equity interests.
• Apply certain discounts and other reductions as provided for by Treas. Regs. 25.2701-3(b)(4).
Step 4 – Subtract value of transferred interest.
Remainder = Value of Gift
$1,000,000
$0
($100,000)
$900,000
35
Minimum Value Rule
Junior equity interests cannot be valued at less than 10% of:
• the total value of all equity interests in the entity, and
• the total amount of indebtedness of the entity to the transferor
36
Recapitalization Of LLC Caused Taxable Gift Under Section 2701
CCA 201442053
• Donor created an LLC and then gifted LLC interests to her children and grandchildren.
• LLC was then recapitalized - in exchange for children’s agreement to manage LLC, all profits and appreciation would be allocated equally to children only, rather than to all members proportionately.
• After the recapitalization, Donor held only a right to distributions solely based on his capital account as it existed immediately before the recapitalization.
• The IRS stated that the recapitalization was a gift from Donor to Children under Section 2701.
• The IRS explained that a gift can occur indirectly through transactions such as a recapitalization. Citing Kincaid v US, 682 F.2d 1220 (5th Cir. 1982).
• Did not have to use § 2701 to find gift here. Compare grant of a profits interest under Rev. Proc. 93-17 – because grant of profits interest as compensation to child in business can trigger § 2701 deemed gift.
37
The 2701 Attribution Rules
• “Attribution to Estates, Trusts and other entities” –
assuming maximum exercise of discretion fbo
• “Grantor Trust Attribution Rules”
• “Multiple Attribution Rules” Treas. Reg. Section
25.2701-6(a)(5) – different tie-breaker ordering rules
apply: Cast a Wide 2701 Net.
• As to applicable retained interests – Attribute to
Senior Member first (Grantor of GT first)
• As to subordinated equity interests – Attribute to
Junior Member first
38
Planning with Freeze Partnerships
FMV Facts & Circumstances
• Yield
• Preferred return coverage
• Dissolution protection
• Voting rights
• Lack of marketability
• Underlying assets
Volatility
Income production
• Market conditions
Valuing Preferred Interest - Rev. Rul. 83-120
Most Important
Rate is lower
redeem
Rate is lower if issuer cannot redeem
40
Valuing Preferred Interest – Market Conditions
• The information provided is acompilation of the returns forpreferred stock issued by publiclyreporting REITS in each sector as ofMarch 25, 2019.
• The information provided is not meantto be used for specific privately heldcompanies without further analysis ofeach issue making up the sector’sreturns. In order to apply a sector'sreturns they most be adjusted tomake them comparable to the subjectcompany to which they are beingapplied.
• Market data courtesy of
www.mpival.com
41
Negative Capital
What is the Basis of Grantor Trust Assets Following Grantor’s Death?
• Property Acquired by Sale - Section 1012
The basis of property shall be the cost of such property
• Property Acquired from Decedent - Section 1014
The basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall . . . be the fair market value of the property at the date of the decedent’s death . .
• Property Acquired by Gift - Section 1015
The basis shall be the same as it would be in the hands of the donor, or the fair market value if lower
43
Uncertainty Creates Risk
Is a Section 1012 or 1014 step-up too much to ask?
• No tax on gain – ever
• No estate tax on trust assets
• Too good to be true?
Rev. Proc. 2015-37
• No more rulings on step up upon termination of grantor trust status upon death of grantor
IRS 2018–2019 Priority Guidance Plan
• Guidance on basis of grantor trust assets at death under §1014
New Form 1065 check-the-box for negative capital accounts
Applies to negative capital account balances not otherwise reported on Schedule K-1.
Penalties apply for failure to report.
44
Liabilities Must be Allocated to Preferred to Obtain Step Up on Negative Capital
How To Structure Freeze Partnership with Negative Capital
45
FREEZE PARTNERSHIP
Senior Preferred
LLC
Family Trust Grantor
Leveraged Real Estate
IRC 704 (c) minimum gain IRC 752
Junior Equity
$222,222 Cash Contributed for Junior Equity (10% $2,222,222)
Children 1%
99%
Contributed Property
$10,000,000 FMV
$8,000,000 debt
$2,000,000 equity
$1,000,000 basis
Structure To Keep Liabilities With Senior
46
Treatment of Liabilities
• The way liabilities are allocated determines partnership “outside” basis – and what gets stepped up upon death.
Treas. Reg. 1.742-1 states basis = date of death value + share of liabilities allocated to the decedent/estate
Section 752(a) increase in the partners share of liabilities is considered to be a contribution of cash to the partnership.
Section 752(b) decrease in a partners share of liabilities is considered to be a distribution of cash.
If the shifting of liabilities causes a partner to be deemed to have received a distribution in excess of that partner’s basis in its partnership interest gain is recognized under section 731(c) of the Code.
Inside basis is stepped up if there is a section 754 election.
47
Allocation Of Liabilities Among Partners
Section 752 governs allocations of liabilities among partners
• Recourse - who bears risk of loss?
Treatment of Nonrecourse debt – three tiered approach
• Tier 1 – Minimum gain
• Tier 2 – Section 704 (c) minimum gain
• Tier 3 – allocation based upon other significant partnership item with substantial economic effect
48
The Leaky Freeze Solution
• Capital Shift
• Capital Strip
49
What is a Capital Shift?
The partners' interests in profits and losses may be altered or “shifted” in a number of ways during the course of a partnership's taxable year
• Shifts may result for many reasons, including for example:
All or a portion of a partner's interest may be sold, exchanged, transferred, or contributed to a trust, etc.
Partnership interests held by partnerships, corporations, or trusts may be distributed to partners, shareholders, or beneficiaries
Shifts may also result from an agreement among the partners to alter their interests in profits and losses
• Freeze Partnership Capital Shift
May decreased the value of the preferred interest for estate tax purposes, while leaving negative capital with Senior for step up
50
FREEZE PARTNERSHIP
Senior Preferred
LLC
Family Trust Grantor
Leveraged Real Estate
Junior Equity$222,222 Cash
Contributed for Junior Equity (10% $2,222,222)
Children 1%
99%
Contributed Property
$10,000,000 FMV
$8,000,000 debt
$2,000,000 equity
$1,000,000 basis
Capital Shift
Senior II
Capital Shift
$1.5 equity(no debt)
51
Sale of Senior II for AFR note
• Leaves negative capital with Senior for step up
• Converts Preferred Return (say, 5% to 8%) to AFR return on “shifted capital”.
• April 2019 Mid Term AFR compounded annually is 2.55%
• No step up on Senior II if sold to Grantor Trust except to extent of installment note
• Estate side concerns regarding IRD if note is outstanding at death.
52
Capital Shift
Capital Stripa/k/a Leveraging Up
Real Estate contributed to Freeze LP
Assets
Real Estate (fmv) $10,000,000
Real Estate (adj. basis)
$1,000,000
Liabilities – Mortgage ($8,000,000)
Net Equity $2,000,000
53
Capital Strip
Balance Sheet
Assets (FMV) $10,000,000
Mortgage ($8,000,000)
Equity $2,000,000
Capital Accounts
Senior $1,800,000
Junior + 200,000
$2,000,000
Preferred Return @ 6%
Senior $1,800,000
x 6%
$108,000
54
Borrow against separate stock portfolio
Investment Partnership
$2 Million marketable securities
PartPerLP1P
FreezePartnership
$1.5 Million AFR Loan
$1.5 Million Distribution To Senior
$1.5 Million Margin Loan
55
Capital Strip
New Balance Sheet
Assets (FMV) $10,000,000
Liability (Mortgage)
($8,000,000)
Liability (AFR Loan)
($1,500,000)
Equity $500,000Capital Accounts
Senior $300,000
Junior $200,000
Preferred Return @ 6%
Senior $300,000
+ 6%
$18,000
56
Capital Strip
Preferred Return ($300,000 x 6%)$ 18,000
Interest on Mid Term AFR Loan ($1.5mm x 2.55%) (4/19)$ 38,250
Total Leveraged Return to Senior $ 56,250
Compare Unleveraged Return ($1.8mm x 6%) $108,000
Compare Installment Sale ($2mm x 2.55%) $
51,000
57
Capital Strip
Contributions Of Encumbered Property And Leveraged Distributions
Disguised Sale Rules of Section 707(a)(2)(B)
• Under regulations prescribed by the Secretary . . . If
(i) there is a direct or indirect transfer of money or other property by a partner to a partnership,
(ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner), and
(iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property . . .
Contribution and distribution will be treated as a sale if the facts and
circumstances indicate that (Treas. Reg. § 1.707-3(b)(1))
• (1) the transfer of money would not have been made but for the transfer of the property, and
• (2) the distribution was not dependent on the "entrepreneurial risks" of the partnership's operations.
• Additionally, if within a two-year period there is a contribution by and distribution to a partner, the transfers are presumed to be a sale of the property to the partnership.
• This presumption is rebuttable only if "the facts and circumstances clearly establish that the transfers do not constitute a sale."
58
Disguised Sale Rules and Leveraged Distributions
Key Takeaways
1. If the debt comes on more than 2 years before the contribution of encumbered property, the disguised sale rules do not apply. The debt is allocated to the contributing partner under section 704(c) principles.
2. Disguised sale rules can limit preferred returns that should be paid during the first 2 years.
3. Leveraged distributions (i.e. debt financed) within 2 years of contribution can be an issue under the disguised sale rules.
59
Freeze Partnership
Senior
RE LLC RE LLC
RE LLC
Family Trust
Grantor Trust
Managing Member Interest
Preferred Interest (6% qualified payment and
Liquidation Preference)Junior Equity
(Growth Interest)
Simple Real Estate Partnership Freeze
60
FREEZE PARTNERSHIP
Senior Family Trust
Real Estate Entity
UnrelatedParties
40% Membership
PreferredJunior Equity
Best Discount Scenario (Contribution of Non-controlling Interest)
61
Freeze Partnership
Family Trust that includes spouse
Undiscounted Assets.
SeniorPreferred Interest (8% qualified payment and
Liquidation Preference)Junior Equity
(Growth Interest)
1992 Regs do not allow intra family discounts!
Reverse Freeze – Remember when there was a return on investment?
62
GST Non-Exempt
Trust
Exempt Trust fbo Child #2 descendants
Child 1 Child 2
Preferred Partnership
Investments
Distribute $22.26M to each child/beneficiary (G-2)
Preferred “Frozen” Shares
$22.36M gift* $22.36 M gift*
*Assuming split gifting with spouse
Common “Growth” Shares
PREFERRED PARTNERSHIP TO CONTAIN GROWTH OF GST NON-EXEMPT TRUST
Exempt Trust fbo Child #1 descendants
63
PREFERRED PARTNERSHIP WITH QTIP FREEZE
Preferred Partnership
Capital Contribution
Capital Contribution
Common
Preferred Coupon
Spouse
Income
* Caveat – Consider potential Section 2519 argument on contribution.
QTIPTrust
Child/Trust
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CARRIED INTEREST VERTICAL SLICE PLANNING
• If Parent makes a Vertical Slice gift of 50% of his $1M GP
interest (= $500,000), he must also make a proportional gift of
50% of his $20M LP capital (= $10M). Total gift of $10.5M x
40% gift tax rate = $4.2M gift tax liability.
GP Carry$1M
LP Capital$20M
Example
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“NON-VERTICAL” PREFERRED PARTNERSHIP
LLC
LLC
FUND
Gift of Common “Growth” Interests in
LLC
Contribute GP and LP Fund Interests
Common and Preferred (with Mandatory Payment Right, Qualified Payment
Right or guaranteed payment) LLC Interests
Preferred
GP LP
Common
Parent
Child/TrustParent
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Recent Developments
• Malpractice case against Lowenstein Sandler and CohnReznick (Feb. 2019)
Advisors allegedly recommended clients with extensive real estate holdings transfer assets by gift and/or sale to dynastic grantor-type trusts. Real estate partnerships allegedly had negative capital accounts.
Clients sued advisors alleging that they never advised them that conveying real estate to dynasty trusts could eliminate basis step-up at death, trigger phantom gains upon termination of grantor trust status and cause loss of future depreciation deductions.
• Form 1065 Check-the-Box for Negative Capital Accounts
Applies to negative capital account balances not otherwise reported on Schedule K-1.
Penalties apply for failure to report.
Increased IRS scrutiny
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