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A Timely Opportunity to Transfer Wealth to Future Generations Tax-Free

November 27, 2012
by Jack Reynolds

In September 2012, I wrote an article about the high impact tax-free gifting limits
that are likely to erode in December 2012. In it, I explained how you can take advantage of this unprecedented opportunity to transfer wealth to grandchildren (even if you do not yet have any) tax-free. In today’s article, I propose yet another timely opportunity to transfer wealth to future generations tax-free — consider your vacation home. Whether it is a cabin in the woods or a grand cottage in Newport, R.I., now is a great time to consider transferring your vacation home to your intended beneficiaries. Importantly, you need not lose control of your treasured vacation home, at least not yet.

Consider these three high-impact year-end tax planning opportunities for your family’s vacation home:

  1. Transfer the property to a limited liability company (or LLC) to create an illiquidity discount. An illiquidity discount allows you to give some of the LLC shares to your intended beneficiaries and retain a majority interest in the LLC. Further, the value of the property represented by the beneficiaries’ shares is removed from your estate, while the value of the LLC shares that remain in your estate will enjoy an impaired valuation due to the illiquidity discount. If you have not used up your $5.12 million (for couples $10.24 million) lifetime gift tax exemption, then the shares that you transfer to your beneficiaries in 2012 will be federal gift tax-free. You may give more shares in future years tax-free, assuming that the annual gift tax exclusion amount survives tax law changes.
  2. Create a qualified personal residence trust or QPRT (pronounced QPert) to transfer property to your beneficiaries over time. You and your advisers can discuss the length of time over which to affect the transfer. With a QPRT, the donor typically retains control of the property for the duration of the trust and when the trust ends, control is transferred to the beneficiary. The donor may also be able to rent the property back from the beneficiary. The tricky thing about a QPRT is that for the tax advantages to be effective, the donor needs to out-live the duration of the trust. If the donor does not out-live the trust then the property is transferred back to the donor’s estate, which can have undesirable tax consequences. Therefore, a QPRT is only appropriate when the donor believes that he or she is likely to survive the trust and is prepared to transfer control of the property to the beneficiary at the end of the trust.
  3. Encourage children or grandchildren to buy your vacation home from you now,and lend them the money to do so. As a part of the transaction, consider entering into a long-term lease in which you would lease the property back from them, terminable upon the death of the seller. A long-term lease would provide you with a great deal of control over the property, and today’s astonishingly low interest rates help keep the sale/lease-back rental payments modest. Further, there is no bank to evaluate the credit qualifications of the buyer/borrower, that part is up to you. If you do decide to lease back the property, make sure that your lease payments are large enough to permit the buyer(s) to service the loan and cover property taxes, insurance, maintenance and repair costs. Documenting and operating the lease in this way gives substance to the transaction.

Please note: While the foregoing suggestions apply with equal force to your primary residence, some donors are more cautious about transferring ownership of their primary residence. However, it is certainly worth considering this opportunity too.

My remarks here are not intended to provide solutions for your particular situation, but rather to provoke a conversation within your family and importantly with your Private Investment Counselor, attorney, financial planner and CPA. This sort of planning is technical and it is important to be guided by qualified and experienced professionals. In addition to my comments, you might find this brief article helpful as well Feathering the Kids’ Nest
by Annamaria Andriotis in the Wall Street Journal on November 16, 2012.

If you would care to chat with me about the topic of this note, please give me a ring at 617.945.5157 or drop me a note at

Bonus Tip: If you have not already taken my brief Investment Assessment Survey
, there are a few days left. It will help you plan and prioritize your 2013 investment decisions regardless of your depth of experience.