1.  Transfers During Life and Death

2.  Basic types of Property Transfer o Sales Full Price at Sale Installment Payments Less than Fair Market Value (Partial Gift) o Exchanges o Gifts  How do these transfers impact cash flow of original owner of property?

3.  A Sale o Arm’s length transaction Property sold for fair market value Wealth “unchanged” by the sale o Installment sale Includes interest and principal Below market interest rates imply partial gift Uncompleted installment payments at death of original owner of property Estate includes future payments  Is there advantages in selling property prior to death?

4.  Example of a Sale – Appreciated Asset o Babe sells appreciated land to Henry Babe originally paid $27,000 for property Henry buys land at fair market value for $74,000 How does this sale impact Babe and Henry’s wealth? Babe’s wealth change Gain on sale ($74,000 - $27,000 = $47,000) is taxable Capital Gains tax ($47,000 x 0.15 = $7,050) reduces wealth But wealth reduction is tax paid at time of transfer and avoids estate tax on gain as new asset (cash of $74,000) is at fair market value. Henry’s wealth change None at this time as he has paid $74,000 (reduction of one asset) for new asset in portfolio worth $74,000 (increase in another asset)

5.  Example of a Sale – Depreciated Asset o Joe sells antique car to Mickey Joe originally paid $56,000 for vintage Rolls Royce Mickey buys car at fair market value for $48,000 How does this sale impact Joe and Mickey’s wealth? Joe’s wealth change Loss on sale ($56,000 - $48,000 = $8,000) is not a tax event No change in wealth just new asset, cash $48,000 replacing an asset that had a fair market value of $48,000 Mickey’s wealth change None at this time as he has paid $48,000 (reduction of one asset) for new asset in portfolio worth $48,000 (increase in another asset) In this example, Joe does not use car as depreciable asset in a business or as an investment, just a personal asset for consumption.

6.  Installment sales o Payment made over a period of time Time value of money implies that the payment includes both principal and interest Irrelevant how seller “uses” the payments – if spent fine, if saved part of estate at death o What is the appropriate interest rate? Should be current market rates Below market rate implies a “gift” How to determine or justify interest rate – For family member, Applicable Federal Rates (page 250)  Allocation of payment to asset basis, asset’s appreciation (capital gain) and interest (ordinary income)

7.  Installment Sale Example on Appreciated Asset o Robinson sells appreciated condominium to Jacoby Robinson originally paid $920,000 for property Jacoby buys property with 10 year loan (monthly payments at 6.5% APR) for $25,000 per month What was the fair market value of the condominium? $2,201,712 Apply monthly payment to Robinson’s income (amortization) Interest payment is $2,201,712 x 0.065/12 = $11,926 (ordinary) Return on Basis is $920,000/$2,201,712 x ($25,000 - $11,926) = $5,463 Capital Gain is [($2,201,712 - $920,000) / $2,201,712] x ($25,000 - $11,926) = $7,611 (taxable at capital gains tax rate) Jacoby’s has no wealth impact or tax impact

8.  Exchange of Assets o If the two different assets have the same fair market value, no tax or wealth implication Simply need to retitle assets (if necessary) Portfolio changes for both parties in the exchange o Example (same FMV) Darwin has home in Chicago and exchanges for a home in LA with Ryan Assets fair market values are the same No tax or wealth implication, just need to retitle property o Example (different FMV) Darwin’s home in Chicago is $200,000 lower than Ryan’s LA home If Darwin does not pay the difference, then the exchange has a gift component, if Darwin pays the difference then even exchange.

9.  Transfers (Gifts) outside of Gift Tax o Medical School or Law School (Professional Graduate School) Tuition and Fees Paid directly to the institution for the student from donor o Gifts to Spouse o Legal Support of Children – can include living expenses while in professional schools o Annual exemption amount for individual gifts  Transfers to Trust o Outright (surrender all interest in property) o Basis of transfer may need to be documented, especially for appreciating assets  Partial Sale - Gift o When the sales price is below fair market value difference is considered a gift o Gift portion may be part of annual exclusion or one-time life exclusion

10.  Sale via Annuity o Private Annuity Asset transferred and buyer to provide annual annuity until death of original owner Annuity payments can be longer or shorter than life expectancy Fair market value of the annuity is based on actuarial tables on life expectancy of the seller o Self Cancelling Interest Note (SCIN) Annuity Same as private annuity but with a maximum payment period Premium on annuity (above private annuity) Asset value to buyer is PV of annuity payments regardless of number of actual payments made. Seller may have security interest in the property (default insurance)  Example of SCIN – Excel Workbook from page 261

11.  Grantor Retained Trusts o In general, the trust is created and the grantor transfers assets to the trust but retains some type of income stream from the trust. The trust is irrevocable and has a specific time period. At the end of the trust’s life, the assets are transferred to the beneficiary of the trust (typically a family member).  GRAT --- Grantor Retained Annuity Trust  GRIT --- Grantor Retained Income Trust  GRUT --- Grantor Retained Unit Trust  The form of the benefit to the grantor determines the type of trust and are typically used to reduce transfer taxes (inheritance or gift) of the grantor or grantor’s estate

12.  Generic Example of a GRAT o Grantor sets up a Trust with children as beneficiaries of the trust o Grantor transfers asset to the trust o Trust is for fixed amount of time, for example, ten year period of time o Trust will pay out to grantor an annual annuity for specific period Annuity is not a taxable gift as it goes to the original owner of the asset The beneficiary will receive a taxable gift at time of transfer with the value of the gift as the fair market value minus the present value of the annuity stream. o Grantor will pay gift tax on transfer to the trust but can use annual and life time exclusions o At conclusion of the trust period, asset passes to beneficiaries at original value of the gift (appreciation not in asset value base).

13.  Numerical Example of a GRAT o Yadi sets up a Trust with Peter and Daisy as beneficiaries o Yadi transfers business worth $500,000 to trust o Trust is for five year period o Trust pays Yadi $30,000 per year annual for five yeears Present value of the annuity stream is based on 0.95% interest Present value is $145,818 Gift to Trust is $500,000 - $145,818 = $354,182 o Grantor will pay gift tax minus any available exemptions ($14,000 per beneficiary and any life time exemption remaining) o After five years, business passes to Peter and Daisy Basis in business is $354,182 and if business has appreciated, capital gains tax will not be imposed until business is sold and gain realized

14.  Difference between GRAT and GRIT o Instead of an annuity, income is distributed to grantor at least annually o Value of the income stream is based on the present value of the income according to 7520 rate. o Income may be above or below the 7520 rate o If beneficiary is family member, present value of income is set at zero and transfer gift value is fair market value  What is a family member? o Spouse, lineal decedents of grantor or spouse (children, grandchildren, great-grandchildren, etc.), siblings (grantor’s brother or sisters), or a spouse of a sibling.

15.  Difference between GRAT and GRUT o Trust pays a fixed percentage of the annual value of the asset in the trust For example, a 15% unit of the trust to be paid annually on a asset appreciating at 7% per year Initial value of the asset when trust set up is $1,200,000 At first anniversary, asset value is $1,200,000 x 1.07 = $1,284,000 Distribution is 0.15 x $1,284,000 = $192,600 Subsequent year value is $1,284,000 - $192,600) x 1.07 = $1,091,400 Distribution in year two is 0.15 x $1,091,400 = $163,710 If unit of distribution is greater than appreciation rate, asset value falls over life of trust. If unit of distribution is less than appreciation rate, asset value increases over the life of the trust.

16.  What happens if grantor dies prior to the trust expiring? o With a GRAT, the remaining payable annuities are part of the gross estate of the grantor o With a GRIT, if beneficiary is defined family member, no adjustments needed and no increase in gross estimate of grantor as the original transfer was not reduced by present value of income stream o With a GRIT, if beneficiary is not a defined family member, remaining interest income as defined by 7520 rate is added back to the gross estate of the grantor o With a GRUT, the remaining estimated present value of future unit transfers are part of the gross estate of the grantor  In general, if the grantor dies prior to the expiration of the trust, most of the tax benefits can be lost with this transfer

17.  Other types of Grantor Trusts o Intentional Defective Grantor Trust (IDGT) Asset placed in trust for heirs (family members) Income of trust remains with grantor and added to personal income for tax purposes Grantor retains rights to exchange assets, provide income from trust to spouse, has revisionary interest greater than 5%, can borrow from trust at reduced interest rates o Qualified Personal Residence Trust Asset in trust is personal residence Interest in property is equitable ownership At expiration of trust, property transfers to beneficiary and grantor may need to move out or pay rent or make other arrangements

18.  Family Limited Partnership (FLP) o Family Limited Partnerships for passing on business o No tax implications at formation as original owner of business still controls the business o Two classes of owners, general partners and limited partners General Partner retains the rights to “manage” the business General Partner liable for the debts of the business General Partner receives benefits from FLP (wages and benefits) When limited partnerships are distributed gift tax may occur Limited Partners receive ownership share but value can be discounted due top limited “voice” Limited Partners typically are not responsible for liabilities of the business

19.  Other Transfers o To Charities (Chapter 9) o Outright Gifts (Chapter 5) o Via Will (Chapter 2) o Through Contract Law (Chapter 3, 4 and 6) Non Probate Property -- Property Rights on Survivorships, Insurance, Pensions, etc.) Probate Process – Challenges to Wills Estate Rules -- Community Property State Laws, Dowry and Curtesy Laws  For and individual, the choice of transfer usually revolves around postponement or avoidance of tax

20.  What are the implications for Financial Planning? o What is the most efficient way to transfer property for the client? o What potential events to the plan may render the transfer choice ineffective or inefficient? Pre-mature death Asset value changes Cash flow needs of the donor/grantor o Changing tax laws o IRS potential challenges to the transfer o Gift tax changes (size of one time exclusion or annual exemption) o Availability of donor or grantor to change mind about transfer at a later date