This reliable strategy can reduce your fees to a great extent

VaselineOctober 2, 2024

0 3 minutes read

This reliable strategy can reduce your fees to a great extent

Editor’s Note: This is part 12 of an ongoing series on using trusts and LLCs in estate planning, asset protection and tax planning. The effectiveness of these powerful tools—especially for asset protection and tax planning—depends heavily on how they are configured to work together and whether certain types of control over assets and property are relinquished by the property owner. See below for links to the other articles in the series.

Upstream estate planning is a strategy that involves giving assets to someone who will die before you to reduce capital gains taxes. This technique is based on the rule that, in order to obtain a step-up in basis, assets must be included in a decedent’s gross estate.

In other words, during the lifetime of a trust maker, regardless of whether the value of a trust’s assets increases or decreases, a trust (neither a revocable trust nor an irrevocable incomplete grantor trust) will not reduce or diminish the tax consequences on capital gains when the producer trust sells the assets. If the trust’s assets have a basis less than fair market value, once the trust sells or disposes of assets through certain transfers, either the trust or the trust creator will have to recognize capital gain (with the gain basically calculated as sale price minus basis) and pay capital gains taxes on the earnings. (If the value of the trust’s assets declines in value, the trust creator or your trust may want to recognize the capital loss.)

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However, if a younger person chooses an older relative, such as an elderly parent, as the beneficiary of the trust, when that older person dies, the assets in the trust will receive a step-up basis and can revert to the property of the younger. person to the higher value.

Here’s how it might work

Example. A parent’s adult offspring has land worth $5 million and a basis of $500,000. In 2020, the child makes a full gift of the land to an asset protection trust with the elderly parent as beneficiary, using $5 million of the child’s lifetime exemption from gift and estate taxes. The child ensures that the entire value of the land will be included in the parent’s gross estate by also giving the parent a general testamentary power of appointment, which allows the parent, upon their death, to leave the land to anyone the parent wishes, including creditors to the parent. The father dies in 2024, when the land has doubled in value to $10 million. Fortunately, the parent exercised the power of appointment in favor of the child, returning the land to the donor child. Fortunately, the parent is adequately exempt from estate tax, so although the land is included in the parent’s gross estate, the land is not subject to estate tax. The best outcome is that because the land was included in the parent’s gross estate, the child gets the land back with an increase in market value at the time of death of $10 million.

How everything is set up is critical

Yes, you read that right – upstream gifts from the younger generation to the older generation create opportunities for intergenerational growth. However, assets gifted from younger generations to older generations must be included in the older generation’s gross estate – potentially taxable.

In addition, assets must be directed through a power of appointment at the discretion of the older generation. Because of the potential for estate taxation by the older generation, as well as the power granted to name trust assets to beneficiaries, this planning technique should be carefully considered.

My next article will be about using LLCs to protect yourself against liabilities arising from the assets held by the LLC.

Vaseline

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