FAQ
Property Types
Insurance
Terminology For Commercial Real Estate
Contractual Information When Purchasing a Property
Lenders & Loan Information
Important Points To Look Out For When Purchasing Commercial Property
Triple Net Properties: What Are They, And Why Do You Want To Own Them
1031 Questions
Estate Planning (Provided by Peter A. Karl III of New York)
Property Types
Why purchase commercial retail properties instead of apartments and office buildings?
Less management and headache, less risk and more free time.
Rural vs. Urban investments
Probably should do both to diversify, but rural you are most likely the only game in town and the cost per sq. ft. is cheaper to build , cap rate is higher and the appreciation is less. Urban locations, hundreds of competitors, higher cost to build, lower cap rate, more appreciation, less return cash on cash at the beginning.
Large box retailer vs. small box.
Large box usually means over 25,000 sq. ft of space and the small box is below this number. Wal-Mart is large box and AutoZone small box as an example.
Shopping center vs. free standing retail, what is the choice?
Shopping center has triple net retailers in them but there is a great deal of management that needs to be addressed and different leases stipulate and regulate other tenants in the center. A single retail free standing building usually does not have management or worry concerning other tenant leases.
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Insurance
What kind of insurance do I need in order to have full coverage?
Earthquake, flood insurance, error and omissions, liability, terrorism, fire and extended coverage for at least the replacement cost of the building.
Terminology For Commercial Real Estate
What does Cap Rate Mean?
Take the net income of the property and divide by the sale price and that is the cap rate in which you are paying. Lower cap rates mean higher price and higher cap rates mean lower price.
What is a LOI?
Means "letter of intent" to move forward with the seller of a property. Non binding just a starting point before a contract is drawn trying to meet what is spelled out in the LOI.
Why are Demographics so important?
Everything having to do with the location of your prospective tenant is important, especially the demographics that represent the household income level, growing or shrinking area, traffic counts and ethnic mix catering to the tenant and his product.
Why should I care about whether my tenant has an option to lease or not?
You better for the tenant has you tied up in a lease for all the option period if they decide to keep the premises they can even sublease for the most part to other tenants and possibly gain what ever increase rent is achieved if your lease is not tight.
What are Bumps?
They stand for increase in the tenant's rent periodically during the lease term. Normally occur over five year periods but some tenants like Walgreens have no bumps
What does IRR stand for?
Internal rate of return, which is a lot more comprehensive than simply a cap rate or cash on cash return. It takes into account the investor's tax rate, depreciation, future appreciation and fees associated with the transactions.
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What does PSF mean?
Price per square foot, which means the cost that the investor is paying for the package deal for the property, building and land. If this number far exceeds the true cost of building the structure and acquiring the land that it is on, the cost of acquisition may be superficially priced too high based solely on the rent that the tenant is paying.
What is boot?
The cash in a 1031 exchange required to match the new replaced property with the old property ratio of debt and cash in the deal. Boot is simply the cash portion of the equation.
What does an investment grade investment mean?
R A T I N G A G E N C Y C R I T E R I A
Much of the debt issued by governmental entities is rated by private, independent bond rating companies. The bond ratings assigned by these companies reflect the degree of risk associated with the bonds. There are three major companies which rate municipal debt issues in the United States:
• Moody's Investors Service; (Moody's)
• Standard and Poor's Corporation; and - (S&P)
• Fitch's Investors Service. (Fitch)
Bond Rating Categories
Each of the rating companies has a rating scale which reflects the degree of risk associated with a bond. High-end ratings reflect the lowest-risk issues; typically these bonds can be issued at lower interest rates.
• The Moody's scale ranges from "Aaa" on the high end to "C" on the low end with seven intermediate categories.
• Standard and Poor's index ranges from "AAA" to "D" with eight intermediate categories.
Bond Rating Criteria
The rating companies use very similar criteria in determining municipal bond ratings. Each identifies essentially the same four principal credit factors which figure into the rating of long- term bonds:
• economic factors;
• debt factors;
• governmental/administrative factors; and
• fiscal/financial performance factors.
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Bond Ratings:
Bond Rating Categories
Although bonds do not legally require a rating, issuers are compelled by circumstances to have most of their large debt issues rated. Investors use the bond ratings to analyze the degree of risk associated with purchasing various public securities. High ratings reflect a low risk of non- payment on principal and interest by the issuer, whereas low ratings reflect a higher risk of non- payment.
There is a clear inverse relationship between bond ratings and the interest rates at which bonds are issued: the higher the bond rating, the lower the interest rate for the bond due to the decreasing risk of default. All long-term bonds rated below the fourth category are judged to be below investment grade (speculative grade) and are often referred to as "junk" bonds.
Bonds are classified into two types for the purpose of the rating process - short and long-term debt. To qualify as short-term debt, issues cannot have maturity schedules of greater than four years. Many bonds with maturity schedules of less than four years and all bonds with maturity schedules of more than four years are considered long-term debt. Standard Poor's and Moody's rate commercial paper on a separate scale from other short-term notes.
Bond Ratings for Long-Term Bonds of Investment Grade
Moody's Aaa, S&P's AAA, and Fitch AAA These ratings are the highest grade a bond can be assigned; Triple-A bonds have a relatively small degree of risk because payment is secured by a stable revenue source.
Moody's Aa, S&P's AA, and Fitch AA These ratings are similar to that of triple A, but differ only in that the revenue sources for double-A rated bonds are slightly less secure than the revenue sources of triple-A bonds.
Moody's A, S&P's A, and Fitch A Considered upper-medium grade, but revenue sources are relatively susceptible to fluctuations in relevant economic conditions.
Moody's Baa, S&P's BBB, and Fitch BBB Medium-grade obligations that are adequately protected and secured, but nonetheless may be unreliable if relevant economic conditions have long- run adverse effects on revenue source.
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet); Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
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Bond Ratings for Long-Term Bonds Below Investment Grade
Moody's Ba, S&P's BB, and Fitch BB Lower-medium-grade obligations that are presently adequately protected and secured, but represent long-term risk whether relevant economic conditions are favorable or not.
Moody's B, S&P's B, and Fitch B These bonds are presently adequately protected and secured and represent risk regardless of economic conditions. In addition, it is likely that future relevant economic conditions will be unfavorable, thus intensifying the probability of default.
Moody's Caa, S&P's CCC, and Fitch CCC Besides future risks typical of bonds in the previous category, these are presently not adequately protected and secured, as present relevant economic conditions pose a threat to revenue source.
Moody's Ca, S&P's CC, and Fitch CC High degree of present and future risk; Greater chance of default by issuer; Debt issued in same conditions which produced CCC rating of a prior issue; Given CC rating because of additional insecurity of being issued after CCC bonds.
Moody's C, S&P's C, and Fitch C For S&P's and Fitch, debt issued at same conditions which produced a CCC-rating in a previous issue is given a C rating because of additional insecurity of being issued after CCC-bonds; For Moody's, these are "the lowest rated class of bonds, and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing".
S&P's CI Reserved for income bonds on which no interest is being paid.
S&P's D and Fitch DDD, DD, and D Assigned these ratings when payment is due and issuer defaults.
S&P's and Fitch Plus (+) or minus (-): Indicate relative standing within the major categories from AA to CCC.
Moody's "1" Used to distinguish best bonds in each of five categories, Aa, A, Baa, Ba, and B.
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet); Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
Short-Term Debt
Moody's rates short-term notes on the Moody's Investment Grade (MIG) scale. Short-term notes issued with variable interest rates are rated by Moody's on the Variable Moody's Investment Grade (VMIG) scale. Notes must have a demand "put" feature to qualify for VMIG designation. The criteria associated with these two scales are identical.
Standard Poor's assigns two ratings to any long- or short-term issue containing as part of its provision a variable rate demand feature. The second rating represents the demand feature. Fitch does not make a distinction as it rates all short-term issues, including commercial paper, on the same scale. Moody's and Standard Poor's rate commercial paper, short-term obligations with a 365 days or less maturity, on a different scale than short-term debt.
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Moody's Ratings for Short-Term Debt
MIG 1/VMIG 1 Superior financial backing; Issuer has access to wide variety of financial protection in the event primary revenue source is weakened.
MIG 2/VMIG 2 Financial backing is strong, but issuer does not have access to as wide a variety of protection mechanisms as notes in higher category.
MIG 3/VMIG 3 Financial backing is still strong but protection mechanisms have the possibility of failure.
MIG 4/VMIG 4 Adequate protection, but specific risk exists with this issue.
SG Inadequate protection of short-term issue.
Source: Public Finance Department, Moody's Investor Service, An Issuer's Guide to the Rating Process, New York, NY, 1993 (information pamphlet).
S&P's and Fitch's Ratings for Notes
SP-1 and F-1 Strong financial backing; Will be given a SP-1+ or F-1+ rating if financial backing is undeniably strong.
SP-2 and F-2 Issuer has satisfactory, but not outstanding, capacity to pay principal and interest.
SP-3 Issuer has only speculative capacity to pay principal and interest.
F-3 Issuer has merely adequate capacity to pay principal and interest, and changes in relevant conditions could easily cause these issues to be of speculative quality.
F-S Capacity of issuer to pay principal and interest is speculative.
D Fitch assigns this rating to issues which are in actual or imminent payment default.
Source: Standard and Poor's Corporation, Municipal Finance Criteria, New York, NY, 1994 (information pamphlet); Fitch Investor Service, Fitch Ratings, New York, NY, 1994 (information pamphlet).
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Contractual Information When Purchasing a Property
With Triple Net Leases what is the normal due diligence time period?
21 to 45 days with earnest deposit refundable if the purchase r is not satisfied with the findings.
How much earnest money is required?
Varies in all deals and the size of the deal matters. The more down the better you look as a purchaser to the seller.
What due diligence is necessary before you should purchase any property?
The more the merrier but must include the following: Title, survey, lease, environmental and building study, zoning report and who is signing on your lease? Corporate or franchise, LLC?
When is the typical closing date scheduled after due diligence?
Usually 15 to 30 days unless the property is being built or the tenant has not yet started paying rent.
Debt against the old property vs. the new one in a 1031 exchange, why do we care?
To avoid any tax burden when trading one property for another make sure the debt is replaced with the same amount or more and use up all the cash or boot when trading into a replacement property.
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Lenders & Loan Information
Lender, what to expect and who to use?
Make sure you line up an experienced lender in the field of expertise that you are purchasing.
Example a triple net retail property, such as a restaurant, should require a lender doing most of his or her lending within that realm of tenancy. Get a lender ahead of time and explain what type of building you intend to purchase.
Interest rate hikes, what happens next?
When lending rates move up one of two things happen. First, the present inventory of commercial real estate investments start to build up and the cap rates move up to reduce the inventory. Or secondly, the present owners try and hold out for the lower cap rates and the product does not sell. Supply and demand will dictate the cap rates. Real estate will find its own price level when sellers realize that the buyers will not pay for the slight margins of return when borrowing money equals the same cap rate they are paying for the property.
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Important Points To Look Out For When Purchasing Commercial Property
How important is the quality of construction?
For resale it is very important even though the present tenant is ok with the construction the next investor or tenant may not be. Masonry is the preferred choice vs. metal.
What is intrinsic value?
A value that you may not see unless you do your homework, such as a lower rent for the neighborhood and that in the future if your tenant left your building, .the next tenant's rent would be for a lot more money creating an extra intrinsic value.
Corporate lease vs. franchisee?
The entity that signs the lease is the most important element of the sale, for if the corporation is a credit worthy entity the property will be worth a great deal more to investors than just a strong franchisee. Always make sure the validity of the lessee and the correct party is the guarantor.
LLC lessee vs. corporation
The major corporation you think is guaranteeing your lease may not be for if they set up a LLC for each separate retail outlet your guarantee is worth a lot less than you think. If one store goes under it may no effect the others.
Risk vs reward
Each of us have a different tolerance to risk and reward, thus the cap rates appeal differently to different investors. Those that want more risk get rewarded with a higher cap rate property and higher return. Those that play it safe, receive a lower cap rate and lower return on investment.
Blue collar area vs. white collar
The national tenants divide territories like a pie. Those that appeal to a lower economic population like dollar stores do great in rural areas vs. stores with high end merchandise such as Niemen Marcus locate in white collar areas for that is where their shoppers live and work. Each entity does well for the key consumer is matched to the retailer in that particular area.
Does your Tenant have any 'outs' in their lease, you better know in advance!
If your tenant has the ability to cancel the lease for various reasons, the investor better know what could trigger this event. For the future value will be greatly affected by this out or what we call option to cancel the lease. Being left with a vacant building can destroy your rate of return expected over the life of your investment.
If a Lessee has first right of refusal, how does that effect a potential sale?
If you are in a trade or 1031 exchange you better know if the tenant can exercise the first right of refusal to buy the property instead of you. For when you submit the contract the tenant may have the right to match your offer and buy it for themselves leaving you out in the cold with no time left to trade for something else.
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Lessee first right of refusal, how does that effect you as a potential investor?
What states have not state income tax on a properties' income?
As of Year 2005 the following have no state income tax
1. Alaska
2. Florida
3. Nevada
4. New Hampshire *
5. South Dakota
6. Tennessee *
7. Texas
8. Washington
9. Wyoming
Many investors see great value in purchasing investment properties in these states to reduce their state income taxes.
* New Hampshire and Tennessee tax dividend income at varying rates.
Strip centers vs. power centers vs. lifestyle centers
Strip centers are usually considered small retail centers scattered in various neighborhoods serving the people that live around its perimeters. Small tenants like fast foods, nail salons, small hardware stores etc.
Power centers are the ones that have a large anchor or two, such as a national grocery chain surrounded by smaller national tenants, like Radio Shack or Sherwin Williams Paint. Lifestyle centers are a combination of larger retailers; sit down restaurants, movie theaters, gyms and residential condos with some office thrown in as a total living experience.
Where are Malls heading?
Malls seem to be changing for the competition for their customers is getting fierce and lifestyle centers are hurting their customer base badly. The mall may be a thing of the past if they don't start attracting the entire segment of society like the lifestyle centers are doing.
What is Common Area Maintenance and who pays for these expenses, landlord or tenant?
Most of the time a retailer, either free standing or in a shopping center must pay their own % of the development, common area maintenance for the grounds and buildings. These expenses are typically, snow, outside grass and bushes, painting striping and sealing of the parking lot and utilities for all outside lights.
Cap on expenses by tenants, why should investors be aware?
In your lease, make sure that the expenses no matter how high they may get, can be passed on to the tenants within reason. For if there is a cap or limit of these expenses in the lease, you the investor will eat their costs and diminish your return.
Modified gross lease, what is the difference?
Your tenant does not have to pay for expenses like taxes and insurance etc. unless the expenses shall increase over the base year of the lease. Thus additional expense after the lease starts are passed on but not the ones that are in place already when the tenant moves in.
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Triple Net Properties: What Are They, And Why Do You Want To Own Them
What is a Triple Net Lease Investment?
Unlike full service or gross leases where the Landlord incurs expenses such as utilities, taxes, insurance, Heating and Cooling (HVAC), Electric, Parking Lot, Common Area Maintence (CAM) just to list a few, with a net-lease the tenant pays for such items. A Net-lease means the actual operating expenses (such as those mentioned above) are not included in the Net-lease rent. For example: Say an office building charges $20.00 per square foot on a full service lease (which means the Landlord pays for all operating expenses). If this was a net-lease where tenant paid these extra expenses directly the lease rate could equate closer to $10-$15 per square foot. To sum up, a net-lease places the burden and responsibility to the tenant and NOT the Landlord.
Explain the difference between a Single Net (N) Lease, Double Net (NN), Triple-net (NNN) Lease and Absolute Triple-net "bonded" lease?
Net-Leases: To simply matters, think of in this way. The more net's the less expenses to the Landlord.
Single Net (N) Lease: The landlord will pay the real estate tax bill and or operating expenses but will get reimbursed to some degree by the tenant (each lease is different). The landlord is fully also responsible for the structural integrity of the building and roof.
Net, Net Leases (Double-Net or NN): Each lease is a little different but in most cases the landlord is responsible for the structural integrity and building roof whereas the tenant takes care of all operating expenses and real estate taxes.
Net, Net, Net Lease (Triple Net or NNN): The tenant is responsible for the building, roof, real estate taxes and insurance, all repairs, maintenance and utility bills.
It's important to realize many landlords’, developers and brokers have different definitions to some degree of what they call what, but what we have mentioned above is the general consensus. We strongly encourage you to involve your legal council to review any lease very carefully before you purchase the property.
What are some major advantages to a Triple-net Lease? Why are they so popular?
Here are some excellent reasons to acquire an investment grade net-lease property for either a 1031 exchange or safe, dependable monthly income.
a. Defer capital gains taxes through a 1031 Tax-Deferred Exchange.
b. Triple Net (NNN) Leases are either 100% management free or very little involvement for the Landlord.
c. Triple net lease property has high residual value and is liquid investment.
d. Get non-recourse, fixed financing for 10+ years with triple net lease properties.
e. CHECK IN THE MAIL WITH NO MANAGEMENT
f. No vacancy factors, tenant improvement costs, management or leasing fees.
g. Location! Location! Location! Properties are typically located in prime retail areas with high traffic counts and great demographics.
h. 10-25 Base Term Leases
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Why Investors Favor Triple-net (NNN) properties over apartments, office, industrial and retail strip centers?
Foremost is the enjoyment of owning income property "hassle free" of management and maintenance! You merely collect a rent check once a month from a tenant that has signed a long term 10-25 year "non-cancelable" lease under which the tenant takes care of paying taxes, insurance and maintenance or capital improvements. For this reason more people own such properties in states outside those in which they live then the other way around! They seek the best property with 50 states to choose from rather than just to settle for a property within 10 miles from where they live. Unlike multi-tenant property, triple nets are "stabilized investments" which is to say they have a known and reliable fixed rate of return from nearly always a brand new building without being subject to the wild swings of office markets and the like as well as the U.S. economy and frequently upsetting world events.
What is the typical price range for these Triple-net (NNN) properties?
This depends on the type of tenant you select. The long answer is $750,000-$7,000,000. Again 97% of the available single tenant triple-net properties fit in this price range, but tenants such as Wal-Mart, Home Depot, Lowe's will cost $15 Million and upwards.
Below is a general range of some of the most common categories of stores.
Dollar Stores (Ex: Dollar General, Family Dollar) $750,000-$1,200,000
Auto Stores (Ex: Auto Zone, Advance Auto Parts) $1,500,000- $2,500,000.
Fast food (Ex: Burger King, Arby's) $1,000,000-$2,000,000.
Sit Down Restaurants (Ex: Applebee's, TGI Fridays) $2,500,000-$3,500,000.
Drug stores (Ex: Walgreen's, CVS, Eckerd's) $4,000,000- $8,000,000
Office Supply (Office Max, Office Depot) $5,000,000-$8,000,000
There are many more categories and tenants, we just wanted to give you a few samples.
Who invests in triple net leases?
Many institutions such as REITS and Pension Funds buy triple net investments but many individuals also find them to be very attractive investments.
How safe are Net-Lease investments?
Real estate investments will vary in risk which has multiple varying elements. Variables to determine such risk include credit of tenant; location, diversification of tenants and rent turn over (plus the costs associated such as re-leasing commission, vacancy factors and tenant improvement costs) are the major categories. Net-Lease investments will usually have a high credit tenant, long term lease (10-25 years), if the tenant is considered "investment grade" then of the risk is even more mitigated, well located sitting on quality real estate, good demographics and most important a high chance of long-term residual value.
Even though apartment complexes, office and industrial buildings, retail shopping centers may "look" like they have higher returns, however when you factor in all the "true" expenses after the entire lease term of all the above factors, there is a good chance the Net-Lease investment will be right up there in overall return with-out the headaches of having to manage the properties and deal with the daily aggravation of owning such properties.
What kind of return will I see?
As of Year 2005 average returns are between 6-8% Cap rates depending on the risk/reward factors. Cap rates do not factor in debt or cash flow. To determine the cap rate, simply divide the Net Operating Income (NOI) by the Sales Price. For those long term investors it's not uncommon to see an Internal Rate of Return (IRR) of 8%-15%. Cash on cash returns (which is simply what make off your initial equity each year without taking into consideration of appreciation of real estate nor equity build up) will range anywhere from 0-9%.
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Are Triple net (NNN) properties are easy to acquire?
Given the "care free" no management hassle feature many of our clients purchase property far away from there home states. Most of the property you will see will be "new" construction with closing occurring upon delivery of the building to the tenant and the commencement of rent. Once you have contracted for a property there is quite a lot of due diligence to be performed by you and your professional advisors (attorney's, CPA's, lenders and accommodators). The good news is that you are primarily re-visiting much of the same investigations and due-diligence already performed by the developer, its lender and the tenant!
Consequently, the transaction is primarily a document (legal) review i.e. lease review and such further review of items as title, survey, environmental reports... Naturally a site visit by you and financing commitment if applicable also apply. Unlike other real estate transaction more "over-night" documents between the parties and counsel occur than anything else. Thus there is a relative ease in acquiring this type of investment and it is set-up to occur rapidly. The speed of the transaction is helpful to 1031 exchange buyers and allows all buyers to "get into" the investment quickly and obtain rental income!
Why don't Walgreen's and many others own their stores?
Most large retailers and restaurant chains (including many Fortune 500 companies) prefer to use their capital for core functions such as operations and growth rather than investing in millions of dollars of real estate. This is not unique to just some retailers but virtually all of them!
Who builds these Triple-Net (NNN) Stores?
In a similar way to the residential industry in where we see custom home builder's build and sell homes, we find a parallel situation in triple nets.
Handpicked "Merchant Developers" are selected by these prominent retailers to build stores in multiple states. It is not uncommon for a large retailer to utilize dozens and dozens of different developers to handle the vast store growth underway in our country. These developers build in accordance with the standards of the retailer in terms of location, construction materials and many other considerations .Layers and layers of corporate approval are necessary before a location is even approved and the same holds true from the first shovel of dirt moved to final construction and occupancy by the retailer as the buildings tenant.
What percentage of the real estate will I own?
The answer is 100%! Not to be confused with a tenancy in common investment where the investor may be one of dozens or even hundreds of individuals and entities owning only a fractional interest. If you would like to form a partnership of family or friends you are free to do so but the choice remains yours alone.
How long are these leases usually?
New Leases terms range between 10-25 years (does not include options).
There are 2nd generation properties on the market that can be acquired with less than 10 years on the lease but quote honestly those can be very problematic for an investor seeking financing. Many will have loans in place that may have unfavorable loan terms that you must accept or pay unreasonable yield maintenance fees.
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Do these leases have rent increases?
Some do and others don’t. It will range all over the board, every tenant is different.
What am I allowed to trade from which can be invested into a Net-Leased property?
Ex: I own a farm or hotel, will this satisfy my trade requirement?
Yes, any property which was held for investment purposes one can trade into another like-kind investment property such as a Net-Leased property. To give an example of what you CAN’T do is sell your house which you reside in and then purchase a Triple-net lease and defer taxes.
Again, these laws are complicated and we highly advise our clients to consult with a qualified tax consultant to complete your 1031 exchange.
Why should I diversify?
Any company can be great one year and horrible the next just from scandals and other unforeseen circumstances. Buying in different retail categories is your safest investment. Restaurants, auto parts, drug stores, tire places and dollar stores are a great diverse group.
Site Potential: what does this mean?
When purchasing your location make sure the potential of the site is in line with the growing or strategic location of the community that lies in. When the growth of the population is moving away from the location that you selected for your investment, the spot must be key to the existing neighborhood to maintain its value in the future.
Income and cost approach very different in determining the value of commercial real estate.
The rent produced by the tenant may artificially increase the value for the building in some respects. The building may cost only $150.00per sq. ft to build but the rent that a tenant may pay could produce a $300.00 a sq. ft price to purchase. The income approach can severally hamper your return on investment when and if the current tenant decides to move out and the building cost you to much in the beginning based solely on that tenants rent. The next tenant may not pay the same high rent and thus your return diminishes greatly. When buying a property always take in consideration the price per sq. ft for the structure and make sure it is not totally out of line with other structures in the area.
Is investing in the USA a safer harbor for your investment dollars?
I would most likely answer that question with a yes, just due to the threat of terrorism and unstable governments abroad. If you have every traveled extensively, when you come back from your trip you are always glad you went but never sorry you're living in the USA. That is my answer to the question of investment.
Why should a investor choose Westwood Net Lease Advisors as their choice broker?
The guiding principal of our firm was in recognizing the growing needs of the new and ever growing triple net investor market. We specialize in assisting investors in valuing and acquiring Single Tenant, Net Leased properties.
Our experienced agents truly specialize in this vital net lease investment real estate segment. Our cutting edge technology and extensive support staff work closely with our brokers in bringing buyers and sellers together.
We represent over 800 merchant developers that build for the largest retail tenants in the USA .These developers build between 10-30 stores per year, which they often sell as investment property to 1031 tax exchange buyers or regular investors. 90% of these triple net leases (NNN) are pre-sold through a select group of net lease brokers who have performed well in past years and have gained the trust of these developers. Westwood Net Lease Advisors is one of those select brokers who can perform.
The market is extremely competitive and "best" properties out there are "not" posted on websites since they are usually pre-sold. By working with our firm we can insure that you will have access to the best performing Triple-net (NNN) properties being built and will be first to learn about such availabilities.
Does your service cost me (the buyer) money?
90% of the time we are compensated by the seller or seller's broker directly. At times, when there is a HOT property for sale and the Seller knows it, he may tell the brokerage community that they need to get compensated from their buyer. Obviously we don't work for free. Usually the maximum we will charge in that circumstance is 1-1.5% max.
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1031 Questions
Why Use a 1031 trade instead of selling outright?
Avoid the 15% capital gains tax and the RECAPURED depreciation tax, also can purchase a higher priced property and gain additional depreciation with purchase by avoiding the capital gains tax.
How long should you hold your property to insure that your 1031 trade works?
Most of the experts say around two years though some investors try for just over a year. IRS is very stern so the longer the better.
Trade Dates must be adhered to without fail in 1031 trade.
45 days for identification of new replacement property and 180 days to close on it.
How important are legal and accounting experts in the deal?
Very important for if you mess up one thing or over look an important element in the lease or 1031 procedure, the purchaser can lose a great deal of value or incur a major tax problem.
Why should I use a 1031 specialist?
For just finding a property is easy, but getting to the finish line with the competitive nature of 1031 trades is very difficult and you need a guided expert regardless of your knowledge. That is why coaches take the athlete to the next level.
When should I consider a 1031 tax-deferred exchange?
If you want to sell real property which you are holding for investment purposes or for trade or business and you plan to reinvest those proceeds in "like-kind" property (other investment real property), you can benefit from doing a 1031 Tax-Deferred Exchange.
Do I need to use an Accommodator?
When doing a 1031 Exchange, there needs to be an independent third party (non-related party) in control of the exchange proceeds. This is usually an Accommodator or qualified intermediary. It can not be a related party such as your brother, your accountant, co-owner, broker or employee.
Can't I leave my proceeds with the escrow company?
No. An escrow company does not qualify as an independent third party. They are considered a neutral third party. Instructing the escrow company to hold your proceeds may be considered constructive receipt by the exchanger and could disqualify the exchange.
If I use an Accommodator, do I still need an escrow company?
Yes. You still need an escrow company to conduct your closing. A Qualified Intermediary will work with the escrow company of your choice to set up your exchange.
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If I am doing a simultaneous exchange, do I still need an Accommodator?
Maybe, it's up to you. Keep in mind that the escrow company should not hold your sale/exchange proceeds if for some reason your sale and your purchase don't close the same day. In this case, using an Accommodator is like buying an insurance policy for any unexpected closing problems that might arise.
Do I need a purchase and sale agreement?
Yes. A Qualified Intermediary company will need a copy of your sales contract between the seller (exchanger) and the buyer to prepare your exchange documents. With any sale of real estate property, you should have a written contract between the parties involved. The real estate purchase and sale agreement and receipt for earnest money is most commonly used when working with a realtor.
If I have already opened an escrow, is it too late to do a 1031 exchange?
No. If you haven't recorded the warranty deed or released possession of the property yet, we can still restructure your escrow for an exchange. Let your escrow officer know you want to do an exchange.
Can I carry a note for the buyers of my relinquished property?
This is something we strongly suggest you discuss with your accountant.
Are there any tax consequences in a Tax-Deferred Exchange?
Yes there can be. There are basic guidelines and rules regulating 1031 exchanges. We strongly suggest that you contact your accountant for advise on your particular circumstances.
What do I need to know about doing an exchange?
You need to be aware of the guidelines and time restrictions. You have a 45-day identification period and a 180-day exchange period that begin the day the warranty deed records on the sale of your relinquished property.
What are the guidelines?
The three basic guidelines for an exchange are (1) the property you are exchanging into must be of equal or greater value as the property you sold; (2) you should use all exchange proceeds; (3) the property you are exchanging into must have equal or greater debt (same or greater loan) as the property you sold. If you don't meet all three guidelines, you could be subject to pay some taxes.
Do I have to use all of my proceeds to do an exchange?
No, but the amount you hold out of the exchange can be considered boot and can be subject to capital gains tax. You will need to work out the details with a Qualified Intermediary, your escrow officer, and your accountant before closing. Once your money is in the exchange, it needs to remain there for acquiring real property.
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What happens to my exchange proceeds while I look for a replacement property?
Your funds are deposited into an interest bearing money market account where you earn the interest. At the end of your exchange, a cashier's check or money order will be sent to you for all accrued interest.
How do I identify replacement property?
After your Qualified Intermediary receives confirmation of your relinquished property recording, they will send you a letter explaining your specific time periods and an identification notice for you to complete and return to us by midnight of your 45th day.
Do I have to wait until my relinquished property records before I look for my replacement property?
No. You can look for your replacement property before or after you sell your relinquished property . Just make sure your escrow officer doesn't record on your purchase until after your relinquished property has recorded. Contact your Qualified Intermediary and they will send instructions to the escrow officers to help coordinate the closings.
Do I have to purchase what I identify?
Yes, but you don't necessarily have to purchase everything you identify. There are different ways to identify replacement property which can make your identification decision a little easier.
Can I change my identification notice if I change my mind?
Only if we receive your new identification notice before your 45 days have expired and you revoke your previous identification notice in writing. Once your 45 days have passed, you must purchase something from your identification notice.
Can I build on property I already own?
No. Exchange proceeds can only be used to acquire real estate property, but you do have some options which we can discuss.
Do I have to hold the replacement property for a certain amount of time?
We suggest holding the property one to two years to prove intent of using the property for investment, but there is no specific time requirement set by the IRS yet. (When buying and selling between related parties, there is a 2 year holding period.)
What happens if after I sell my relinquished property, I can't find a replacement property within 45 days?
If you cannot or do not identify replacement property in writing before midnight of the 45th day, your exchange has failed and your Qualified Intermediary company will refund to you, via cashier's check, your exchange proceeds plus any interest earned during the 45 days.
How can I qualify to pay NO taxes when I sell my property?
Any investor can qualify! Section 1031 of the IRS code lets you sell your property and buy a new property without paying any taxes. You simply follow specific rules. A professional qualified intermediary can help you qualify and gain the advantages of a 1031 tax free exchange.
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What is a qualified intermediary?
The IRS says if you touch the money, you pay the tax. However, if you use a qualified intermediary to transfer the money from the sold property into the purchased property, you qualify for a tax free exchange. The qualified intermediary provides a "safe harbor" for your funds. A qualified intermediary will consult, structure, guide and document the exchange transaction from beginning to end. The IRS does not permit your accountant, attorney, or escrow company to be your qualified intermediary. So your qualified intermediary will work with your attorney and CPA to ensure your tax fee exchange goes smoothly.
How do I choose a qualified intermediary?
To ensure the safety of your funds, you should contact your real estate professional, title and escrow company, attorney, or CPA for references to a reputable qualified intermediary.
Can I avoid paying taxes forever?
Yes, you can. By simply following the 1031 exchange rules every time you sell one or more properties and buy replacement properties, when you die your estate escapes all the capital gains taxes forever!
What exactly are the tax advantages in exchanging?
You can eliminate paying any capital gains taxes, and you can eliminate paying the even higher-rate taxes on the recapture of depreciation you've taken on your property. By exchanging into a higher priced property you'll also gain additional deprecation deductions which can increase your after-tax income.
Are there reasons to exchange other than tax advantages?
Yes, there are many non-tax reasons to exchange. For example, if you no longer like managing property, you can exchange your management intensive property for triple-net management free property, or exchange multiple smaller properties for one that can be professionally managed. Or, say your current property cannot be easily refinanced. You could exchange out of that property for a new property which could be refinanced more easily so you can take some cash out. Or, you might exchange to improve cash flow.
What kind of real estate qualifies for a 1031 exchange?
Almost every kind of real estate is considered "like kind" and can be exchanged for any other real estate, including vacant land for apartments, a rental house for a shopping center, an office building for a leasehold interest with 30 years or more remaining, as long as you hold them for investment or business use. Check with a qualified intermediary on the specific properties.
How long can I take to buy a new property?
You have 180 days between the closing date on the sold property and the closing date on the purchased property.
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Can I buy a new property before selling my old one?
Yes, you can buy a new property before selling the old property and still qualify - it's called a "reverse" exchange. The qualified intermediary takes title to the new property you buy and holds it for you until you sell your old property.
Can I get money out of the exchange tax free?
Yes, one way is to complete the exchange first and then refinance the new property.
Can I refinance without blowing the tax free exchange?
Yes, you can refinance the property you are selling before you exchange, or refinance the property you are buying after you exchange, and the proceeds are tax-free. The timing and contract dates are critical though, so be sure to check with a qualified intermediary for the details.
Can I buy more than one piece of property tax free?
Yes, you can acquire any number of replacement properties.
Can I exchange several smaller properties for a larger one?
Yes, you can sell any number of smaller properties and trade up to a larger one.
How do I exchange into a larger property (trade up)?
You trade up by getting a bigger loan on the new property, or adding cash, or equities in other properties, or notes carried back from the sale of other properties, etc. Done right, it's all tax free.
Can I carry back a loan on the property I'm selling and still have a tax free exchange?
Yes, the payments you receive are taxed as you get them, on an installment sale basis. The balance of your equity is exchanged tax free.
I've already sold my property. Can I still do an exchange?
Yes, provided your sale has not closed yet. Contact a qualified intermediary to turn your taxable sale into a tax free exchange with some simple paperwork. You can open an exchange right up until the day before closing.
Okay, so how do I get started?
Call a qualified intermediary, and discuss your 1031 exchange with a knowledgeable tax/legal advisor. The qualified intermediary cannot, by law, be your tax or legal advisor, but can work closely with and provide guidance to you and your advisors.
DISCLAIMER: This is not intended to be tax advice. You are advised to consult with your own tax/legal advisors, as your individual situation is unique. All information contained herein is from reliable sources but is not guaranteed to be applicable to your individual situation or accurate in your circumstances.
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Estate Planning (Provided by Peter A. Karl III of New York)
What determines whether an estate plan should encompass a revocable living trust (RLT) or a last will and testament (LWT)?
Using an RLT accomplishes living probate in which assets are retitled following the execution of the trust documentation. An RLT avoids the expense and delay associated with probate, which is the process of retitling assets from the name of the decedent to the beneficiaries named in the LWT.
Consider the following when deciding which format to use:
When an individual owns real estate located in more than one state, usually an RLT can avoid ancillary or another probate procedure in the second state. The more varied and substantial the asset holdings, the more costly the estate administration will be (it can be completely avoided with an RLT).
If a will contest by a family member is anticipated, using an RLT is recommended because it does not provide heirs an opportunity to dispute the will through the probate process. The contesting party would have to file a lawsuit on the basis of contract law, which procedurally is a more difficult task than contesting an LWT. Additionally, there is a presumption of validity with respect to a trust; the person disputing the trust has the burden of rebutting its validity.
An RLT is not required to be filed in court (unless there is a rare judicial challenge). Consequently, the trust and its accompanying assets are not a matter of public record.
A pour-over will is always needed in conjunction with an RLT to address those assets that have not been previously retitled to the name of the trust (e.g., an inheritance received immediately prior to death).
When is an irrevocable living trust (ILT) useful in elder planning?
An ILT is an alternative to the outright distribution of property to a beneficiary for reasons such as a concern over the windfall nature of an outright transfer to the beneficiary who (because of age or other circumstances) warrants asset preservation through entity insulation and needs to have the future distribution of the ILT assets controlled; a transfer of the income tax burden from the creator of the trust to its beneficiaries age 14 or older (provided student financial aid implications are reviewed). This assumes that the ILT is not an accumulation trust but a conduit one;
freezing the value of assets to save estate and generation-skipping taxes (e.g., by using a dynasty trust); or
elimination of estate taxation attributable to life insurance proceeds.
What is the benefit of using a split interest trust (SIT)?
The most widely used SITs (even by individuals in their 70s and 80s) are the grantor retained annuity trust (GRAT), the grantor retained unitrust (GRUT), the qualified personal residence trust (QPRT), and the personal residence trust (PRT).
A SIT provides benefits to the creators of the trust for a stated period of time. If the grantor lives beyond the designated term, none of the assets within the trust are included in the individuals estate as long as the trust qualifies under IRC section 2702. The GRAT stipulates the right to receive a fixed payment of income, while the amount distributed by a GRUT is based on a fixed percentage of the trusts value, determined annually. The QPRT retains occupancy of the principal residence for the trust grantor during a stated term. A second or vacation home can be used within a PRT with provisions addressing usage, expense sharing, and death of a beneficiary.
These irrevocable trusts are sometimes referred to as marital deduction substitutes because the effect of the split interest provisions is to leverage the unified credit. For example, they allow a widow to freeze the value of appreciating property by transferring it at a discount to a SIT. Because the gift is a future interest, the valuation is based on the present value of the remainder interest, under the principle that the longer the term of the donors retained interest, the lower the amount of the gift. This transfer could be valued at zero if the retained interest equals the value of the property gifted to the trust.
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Why are testamentary trusts useful in elder planning?
Using a testamentary trust within the language of a LWT or RLT funded with assets after the death of an individual can provide the following benefits to the designated beneficiaries:
Providing for the continuity of ownership and postmortem control of particular assets, such as shares of a closely held corporation.
Establishing at the death of the first spouse a unified credit trust (UCT), which is ineligible for the marital deduction. The UCT provides income to the surviving spouse along with principal distributions pursuant to ascertainable standards under IRC section 2041 (i.e., the health, education, support, and maintenance of the beneficiary). This arrangement should be particularly considered when the combined assets of the two spouses are estimated to exceed the amount of the unified credit available upon the death of the second spouse (or if there is concern regarding the status of the estate tax law after 2010). An additional benefit is that the trust assets will be sheltered in the event of a creditors claim against the surviving spouse (such as from a nursing home).
Preventing a premature windfall to a younger beneficiary by providing a testamentary trust with sprinkling provisions of income and principal at the sole discretion of the trustee to a certain age (e.g., age 25). This may also protect the trusts income and assets from being included in the calculation for student financial aid qualification.
Disbursing income (and optional principal distributions) to the spouse from a second marriage in order to preserve assets for the decedents children. In this situation, the need for a waiver should be considered with respect to the right of election that the surviving spouse would have against the estate of the deceased spouse.
What tax complications exist in using testamentary trusts?
The highly compressed tax brackets applicable to taxable trusts should mandate to the document drafter that income be set aside on behalf of any beneficiary under, for example, age 25, or distributed outright in order to avoid taxation at the entity level.
If Subchapter S stock will be an estate asset, the testamentary trust should be drafted to qualify as an eligible shareholder in order to avoid revocation of the S election after the two-year grace period afforded to estates.
Any trust (including a testamentary one) that is a beneficiary of an IRA or a qualified plan must meet certain requirements in order to qualify the recipients named within the document as designated beneficiaries. This means that the trust (which becomes irrevocable as of the IRA owners death) lists all of the beneficiaries as identifiable individuals. In addition, a copy of the trust instrument must be provided to the IRA plan administrator.
What elder-planning issues exist with respect to IRAs?
An IRA (along with any pension plan) of a community spouse is an exempt asset not requiring liquidation toward the costs of the institutionalized spouse; however, the amount exempted counts toward the CSRA and, because the account must be in a periodic pay status in order to qualify for this exemption, the income will be factored into the calculation of the CSIA.
Retaining the account owners name on the IRA after death in order to create an inherited IRA (stretch IRA) should be considered. Unlike a surviving spouse, a nonspouse IRA beneficiary does not qualify for a rollover. Consequently, the account title for a child beneficiary needs to reference the deceased IRA owner such as X Financial Institution as Custodian for Y, deceased for the benefit of Z, beneficiary. This will allow for maximum deferral, if desired, because annual withdrawals will be based on the beneficiarys life expectancy using the applicable divisor in the uniform tables from the regulations under IRC section 401(a)(9). Upon this individuals death, the deferral can be continued by designating a successor recipient of the IRA who retains the aforementioned account titling using the applicable divisor in each successive year as the deceased beneficiary would have used.
An IRA that has several beneficiaries can be divided into separate accounts for each individual either during the owners lifetime or by December 31 of the year following death. This will result in the tax deferral of the payouts based on each recipients life expectancy. Similarly, in lieu of having one trust with multiple beneficiaries of various ages, separate trusts qualifying the respective recipient as a designated beneficiary should be used so that each individual can defer his allocable share of the decedents IRA over his own life expectancy (instead of being required to use the oldest recipients age).
There must be verification that the withdrawal of an individuals Required Minimum Distribution has occurred, particularly when the individual has a terminal illness.
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What are the tax traps in the gifting of assets to third parties?
For the transfer of an asset, such as an IRA or annuity with built-in gain that will be recognized upon transfer, the income tax implications must be reviewed. In every situation (including lifetime transfers of property to irrevocable trust and charities), the issue of liability over basis should be reviewed. If the property transferred has a mortgage with a principal balance in excess of its adjusted tax basis (ATB), the transfer will result in a deemed sale to the extent of the difference.
Despite the desire of elder individuals to undertake outright transfers to their children, transferring property that will result in a deemed sale requires additional consideration. These assets (such as appreciating stock) are best retained or given to charity; assets having a nominal difference between the FMV and ATB (e.g., cash) are preferred for lifetime transfers to family members. Appreciated assets that are retained for subsequent distribution through an estate are entitled, under current laws, to a stepped-up income tax basis.
The transfer of a principal residence to children will result in the resident parents losing the IRC section 121 gain exclusion and applicable property tax exemptions (such as New Yorks STAR Program).
What problems are associated with having all of a familys assets titled jointly by a husband and wife?
Having all of the assets titled jointly between spouses (sometimes known as the poor mans will) is sometimes acceptable for smaller estates, but this co-ownership arrangement does not address circumstances such as the simultaneous death of a husband and wife.
For individuals potentially facing an eventual estate tax burden, joint titling does not take advantage of the unified credit in the estate of the first spouse to die (besides providing no asset protection to the surviving spouse). In addition, when established between spouses involved in a second marriage, these arrangements result in the surviving spouse having full control of asset disposition at death, which may not be the intention of both parties while alive. Circumstances such as these dictate establishing and funding a testamentary trust, as discussed in Question 4.
How often should the beneficiary designations of nonprobate assets be reviewed?
The beneficiary designations of all nonprobate assets should be periodically reviewed in order to update the designations and evaluate the need for the use of a testamentary trust for protecting assets. This is particularly appropriate after the death of the primary beneficiary or following a divorce.
Nonprobate assets include IRAs, life insurance, annuities, and pension plans for which both the primary and contingent beneficiaries should be checked for the following reasons:
The possibility that children could receive outright distributions that would be a windfall in their minds or that of a student financial aid department.
The surviving spouse may need asset protection because of the possibility of subsequent institutionalization in a nursing home.
Preserving assets for the children of an earlier marriage. Subjecting a nonprobate asset to probate because the estate is the contingent beneficiary by default when no secondary recipient has been designated.
The estate plan may reflect an overqualification for the marital deduction if the spouse is named as the beneficiary of the nonprobate assets to the exclusion of using the unified credit. This premortem determination is preferable to subsequently using a postmortem disclaimer.
Why should disclaimers be factored into elder-planning recommendations?
A qualified disclaimer or renunciation filed within nine months of an individuals death is a refusal to receive assets left under an LWT or an RLT, as if the disclaiming beneficiary had predeceased the decedent. This can be a total or partial election and, to the extent elected, is not deemed a transfer for tax purposes by the disclaiming party. This individual is usually the surviving spouse, with the assets then directed to the next generation of the family in order to prevent the unified credit from being underused. Alternatively, the recipient could be a testamentary trust (of which the spouse is a beneficiary) contained within the language of an LWT or an RLT, such as a UCT. This document could be drafted to be a disclaimer trust, to take advantage of the increasing unified credit over the decade and uncertainty of the estate tax laws after that time. The UCT, as a testamentary trust, can also protect the assets that are funded within it from creditors, such as a nursing home.
In addition to being used for property subject to probate, a disclaimer can be filed against nonprobate assets, including real estate held as joint tenants or life insurance proceeds; assets that would have been received under intestacy (i.e., in the absence of the decedent leaving a will) can also be disclaimed. It should be noted, however, that a disclaimer by a surviving spouse could be deemed an impermissible transfer if this individual submits an application for Medicaid within 36 months of the renunciation. Similarly, a spouse receiving Medicaid benefits may be required to file a spousal right of election against the estate of the deceased spouse whose testamentary plan directs all of the assets to the children.
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What elder-planning considerations are applicable to life insurance?
Life insurance can be used as a capital-shifting device as long as underwriting standards do not make the cost prohibitive. For example, when a taxpayer is receiving taxable distributions from an IRA, a portion of the withdrawals could be put toward life insurance premiums (such as for a second-to-die contract) owned by a third party or an ILT. The result is that the proceeds, when received, are not taxable for income or estate purposes and act as a kind of wealth replacement device (for the taxes incurred by the estate attributable to the IRA). This strategy is also applicable to distributions from any other tax-deferred account, such as an annuity or a 401(k) plan, in light of the substantial dilution in value due to eventual taxes. The result, with certain substantial account accumulations, is that only 25 cents of every IRA dollar would remain for the nonspousal beneficiaries after the payment of the associated estate and income taxes. For example, a widower who is over age 70As will be obligated to commence required minimum distributions (RMD) from his IRA. If these RMD proceeds are not needed for daily cash flow, these annual distributions, after taxes, could be applied toward premiums for a life insurance policy (owned by an ILT or his adult children) with guaranteed level premiums until death.
For a widower or widow, the ownership of an insurance policy should follow the beneficiary designation (or be in the name of an ILT if there is a need for the proceeds to be held in trust because of the recipients age or marital situation). This will remove the death benefit from the taxable estate of the decedent. If this is not accomplished when the policy is applied for and issued, any subsequent transfer is subject to the in contemplation of death rule, which results in the inclusion of the death benefit in the taxable estate during the three years following the change of ownership.
Even when a spouse is the beneficiary of an insurance policy, a life insurance trust should be considered, subject to the three-year contemplation of death rule. This is a form of ILT in order to carve out the face value from any estate taxation while not using any of the unified credit. In addition, the ILT can control the disposition of the proceeds following the death of the insured.
A determination should be made as to whether or not an IRC section 1035 rollover is appropriate. A tax-free exchange of one whole life insurance policy for another (or one annuity for another) may be beneficial if the product is producing a low rate of return. Alternatively, an older universal life insurance (ULI) policy may be imploding as a result of unrealistic interest-rate assumptions made at the time the policy was issued. Last, an IRC section 1035 rollover of a policys accumulated cash values to a different policy could, where the need might now exist, provide additional insurance protection with a higher face value as a result of a lower allocation to the investment portion of the policy.
In a distressed financial situation involving an individual whose life expectancy is less than 15 years (due to age or illness), a predeath appraisal of the contract might be warranted to determine if a sale by the policy-owner or insured is appropriate. The premortem life settlement proceeds will not be taxed to the extent of the owners cost basis (i.e., accumulated premiums paid to date); there would be ordinary income to the extent of the difference between the cost basis and the cash surrender value. For example, if a term life policy having a face value of $500,000 is sold for $300,000 and $50,000 in premiums has been paid to date, the first $50,000 would be tax-free and $250,000 would be taxed as capital gains. This strategy would be appropriate only in unique circumstances, because the transaction converts what would have been a nontaxable event at the time of death to a taxable event in the present.
Why is a family limited partnership beneficial?
A family limited partnership (FLP) is the only type of legal entity in which individuals can hold a superminority interest (e.g., the elder parents as general partners with a 2% interest) while having supermajority control (98% interest held by the children) over the limited partners.
This entity can be useful in certain situations:
It can reduce the value of the estate through the use of valuation discounts as a result of the principle that the sum of the FLP interests is less than the value of the underlying assets held by the entity because of a lack of control, marketability, and liquidity of the ownership units. As a result, the Medicaid ineligibility period (per the calculation in Question 8) may be reduced by discounting this entitys underlying assets.
Where there are asset protection concerns of the younger generation due to potential divorce or lawsuits, any creditor would be required to obtain a charging order in order to obtain benefits from the attachment of the limited partners interest. Property that is retitled to the FLP will also have its accompanying income and other distributions controlled by the general partners, the parents.
When out-of-state real property is held by the FLP, the FLP may eliminate future probate costs (and possible nonresident estate taxation) because the real estate will be converted to intangible personal property.
Cash flow emanating from the underlying assets (and the accompanying income tax burden) can be shifted to the younger generation.
Taxpayers should be aware of the IRS negative stance on FLPs, as demonstrated by its decision in the recent case Strangi v. IRS (TC-Memo 2003-145). (Additional information regarding the use of FLPs can be found Twenty Questions on Selection of a Legal Entity, The CPA Journal, August 1999, and Twenty Questions on Protecting Business and Family Assets, The CPA Journal, February 2000.)
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What strategies can be considered nearly universal in elder planning?
A life estate arrangement for a personal residence is preferable to an outright transfer or bargain sale to family members. The elder parents retain the lifetime use of the property and the children receive the remainder interest. The use of a life estate generally preserves the availability of the existing real property tax exemptions and a portion of the principal residence gain exclusion under IRC section 121. The life estate strategy also currently provides a stepped-up income tax basis of the residence to the remaindermen at the death of the life tenants. This strategy prevents any portion of the remainder interest from being factored into Medicaid consideration after the 36-month look-back period has elapsed.
Parents who anticipate family battles regarding disposition of personal property with sentimental value should draft a letter of instruction to the attorney, the executor, or the successor trustee of an RLT, that names the recipients of specific property.
The LWT or RLT of an elder clients parents should be reviewed when an anticipated inheritance must be factored into the estate plan by determining whether these assets should be subsequently partially or totally disclaimed. Alternatively, the parents documents can be revised to provide the benefits in trust in a sprinkling format for their children or grandchildren (after reviewing any generation-skipping tax implications) in order to protect these family assets from creditors or estate taxation.
A qualified terminable interest property trust (QTIP) should be used when the assets of the decedent are placed into a testamentary trust for the benefit of a surviving (second) spouse while preserving the underlying principal for the children. Besides providing mandatory life income (or use of the QTIP trusts assets), an optional provision can be included for the distribution of principal at the trustees discretion under an ascertainable standard (the health, education, support, and maintenance of the beneficiary). An important consideration is the choice of the QTIP trustee in order to avoid conflicts between the surviving spouse and the stepchildren. Using an independent and professional trustee, either as the sole fiduciary or in the role of a third co-trustee in addition to one from each family, may be necessary. Also, a spousal waiver of the right of election should be executed at the time the LWT or RLT is signed.
Addressing the valuation and method of payment for the family business prior to the death of the parents is extremely important, especially when there are other children not involved in the enterprise.
Consideration should be given to using an IRC section 1031 exchange or a CRT to increase the cash flow generated from the real estate portion of the taxpayers investment portfolio (see Twenty Questions About Deferred Realty Exchanges Under IRC Section 1031, The CPA Journal, May 2003). Alternatively, any C corporation (facing significant gain from the asset sale of its underlying business, real estate, or marketable securities such as in the case of a personal holding company) could use a hybrid bailout strategy. This involves an asset sale to a third-party buyer and a subsequently executed stock purchase agreement with a second corporate entity (such as one in the asset recovery business having substantial accumulated losses) seeking to buy a corporation at a premium that has gain to be recognized.
Because some retirees are undertaking a more active role in managing their investments, there may be an interest in converting an IRA to a self-directed account that would be permitted to buy and sell (under its tax-free umbrella) such nontraditional holdings as private mortgages and investment real estate.
For nonresident taxpayers retaining realty in New York, consideration should be given to using an entity (other than a C corporation) as the titleholder for the real estate in order to determine whether potential income and estate tax savings are available. This conversion results in the real estate being treated as intangible personal property (i.e., the associated ownership interest in the entity) for the nonresident. This distinction is important because the real property will be deemed located in the state where the real estate is located, while intangible personal property is treated as being located in the state in which the owner is a resident.
The 5% capital gain rate can be utilized by any family member whose ordinary income tax bracket does not exceed 15% (i.e., 2003 taxable income under $28,400 for single filers, $56,800 for joint filers). Consequently, consideration could be given to gifting an asset (or partial interest) to a child or grandchild over age 13 (after taking into consideration student financial aid implications). Second, for every $2 of earned income in excess of $11,640, Social Security recipients under age 65 will see their 2004 benefits reduced by $1. Last, Social Security recipients of any age should be aware of the income level at which the percentage of benefits included in taxable income increases from 50% to 85%: $34,000 for single taxpayers and $44,000 for joint filers in 2003.
Realize that as elderly individuals advance in age, they become more susceptible to con artists, particularly those representing charities. An annual publication from the New York State Attorney Generals Office (www.oag.state.ny.us) titled Pennies for Charities outlines the portion of every dollar being directed to charitable organizations in New York State. Additional information concerning many charities is available online at www.guidestar.org.
While the federal estate tax burden is being reduced over the decade, taxpayers in states such as New York must be mindful of the potential for state taxes being assessed for estates over $1 million as a result of the recent change to the state death tax credit under IRC section 2011. For example, in 2004 and 2005, for a taxable estate of $1,500,000 there would be no federal estate taxes but a New York State assessment of $64,400.
Besides the execution of a durable Power of Attorney, one should also consider adding language to a separate Health Care Proxy that would allow the health care agent to receive private medical information that might otherwise be unavailable under the Health Insurance Portability and Accountability Act (HIPAA).
Peter A. Karl III, JD, CPA, is a partner with the law firm of Paravati, Karl, Green & DeBella in Utica, N.Y., and a professor of law and taxation at the State University of New YorkInstitute of Technology (Utica-Rome).
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