#gifting

When it comes to effective estate planning and wealth transfer strategies, Grantor Retained Annuity Trusts (GRATs) stand out as one of the best tools. They were popularized by the Walton family (best known for founding the retailers Walmart and Sam’s Club) as a way to get around owing the IRS millions in taxes. This strategy has been used by many other notable individuals like Phil Knight, the founder of Nike. You do not need to be a billionaire to get the same benefits!

A GRAT is an irrevocable trust into which an individual places an asset with the expectation that it will grow in value. In exchange for putting assets into the trust, the individual receives annuity payments for a specified number of years. At the end of that term, any assets left in the trust (typically the appreciated value) are transferred to the beneficiaries (like your children) tax-free.

Think of a GRAT like a special box where you put an asset (e.g., stocks, real estate, or other investments). This asset might be worth a certain amount today, but you believe it will be worth more in the future. The GRAT allows you to benefit from the asset’s growth while minimizing potential gift or estate taxes.

How does a GRAT work?

Imagine that a stock is like a Luke Skywalker action figure toy that’s worth $10 today, but you think it’ll be worth $100 in a few years.¹ You want to give this stock (toy) to your child in the future, but if you wait until it’s worth $100, you might have to pay a big gift tax. So, you use a GRAT:

1. You (the grantor) put the toy (stock) in a special box (the GRAT) and say that for the next few years, the toy will pay you back a little bit of its value each year. This “payback” is called an annuity. The annuity can be a stated dollar amount, fixed fraction, or a percentage of the initial fair market value of the property transferred to the GRAT.

2. If, at the end of those few years, the toy has grown in value more than you expected, everything extra (the remainder interest) goes to your child without any gift tax. *The value of the remainder interest is determined by subtracting the present value of the expected future annuity payments from the fair market value of the original transfer to the GRAT.

3. If the toy doesn’t grow in value, or if it’s worth less, that’s okay! You just got your annuity payments, and the toy goes back to you, so you’re still able to play with the toy after it spent its time in the GRAT.

Example:

Why Use a GRAT?

1. Tax Efficiency – When setting up a GRAT, the value of the gift is reduced by the annuity payments you’ll receive. If the assets grow more than expected, the excess growth passes to your beneficiaries free of gift tax.

2.  If the assets don’t appreciate as much as you hoped, no worries. The assets just revert to you with no adverse gift-tax consequences.

3.  Asset Protection – Assets in the GRAT are generally protected from creditors.

A Few Things to Remember:

• Timing is Essential – GRATs work best in low-interest-rate environments because the assets in the GRAT only need to outperform the IRS’s set interest rate (often referred to as the “Section 7520 rate”) to provide a benefit.
• Risk – If the grantor (the person who set up the GRAT) dies during the trust term, most or all of the trust assets may be included in their estate for tax purposes. Hence, it’s essential to select an appropriate trust term.
• Legal Counsel – Setting up a GRAT involves specific legal processes and paperwork. Always consult with an attorney or financial planner familiar with GRATs and your personal financial situation.

GRATs offer a unique avenue for individuals to pass on appreciating assets to beneficiaries in a tax-efficient manner. Like all financial strategies, it’s vital to understand the ins and outs and seek expert advice tailored to your needs. Remember, as with all financial decisions, it’s always wise to consult with a trusted financial advisor or attorney to ensure that a GRAT is right for your specific situation.

1. A 1978 Luke Skywalker figurine sold for $25,000 in 2015 as part of a $500,000 Star Wars collection at Sotheby’s.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Crystal Kessler, CFP®, Wealth Advisor/Financial Planner

Proposition 19 limits property tax increases for seniors, disabled persons, and disaster victims needing to replace their home, and limits property tax increases on transferring family homes used as primary residences. Proposition 19 or The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act was built off the passage of Proposition 13 back in 1978. Prop 13 limited the amount of property taxes to 1% of a property’s assessed value and capped any increase for assessments at 2% a year. Prop 13 only allows property to be reassessed at market value if there is a change in ownership or new construction. Now with Prop 19, it allows a primary residence’s taxable value to transfer as is to:

1. Individuals over age 55, severely disabled, and disaster victims to transfer their “taxable value” of their primary residence ANYWHERE in the state of California to a replacement residence. However, there are stipulations that apply which will be explained below.
2. A transfer of a family home or family farm between parents and their children if the property continues to be a family home. The child must live in the home as their primary residence and meet a value test, explained below.
3. A transfer of a family home or farm between grandparent’s and their grandchildren with the same stipulations for transfers between parents and children and the value test, but to qualify for this transfer the parents of the grandchild must be deceased.

For seniors over age 55, severely disabled persons, and disaster victims to transfer their original taxable value, the replacement residence or newly constructed residence must meet certain requirements:

• Replacement residence must be purchased within 2 years of the sale of the original home.
• Original and replacement property must be eligible for the homeowners’ or disabled veterans’ exemption meaning one must occupy the property as their primary residence.
• An application must be filed to transfer the owners’ current taxable value to the replacement residence.
• For disaster victims and severely disabled, they can be of any age, but the above requirements still apply.
• For disaster victims, the damage must be from a wildfire, or a Governor declared disaster.

Important Note: There is no limit to the market value for the replacement property compared to the original primary residence, but the replacement property market value amount above the original primary residence market value is added to the transferred taxable value.

Example: Joe and Susie ages 60 and 61, living in Los Angeles want to move closer to their children in San Diego now that they are retired. Joe and Susie bought their home in 2001 when their original taxable value was $300,000. Over the years their primary residence has grown to be $1 million, but due to Prop 13 their property taxes have been capped on increasing and being reassessed at the properties market value. Now that they are moving, Prop 19 will allow them to transfer their current taxable value of their original property to the replacement property.

1. If the market value of the replacement property’s value is more than the market value of the original primary residence, then the excess amount will be added to the taxable value when transferred. Meaning, if Joe and Susie find their replacement property is over $1,000,000 (what their current home’s fair market value is) and for example purposes we will say the replacement property is $1,100,000, they will have to add the difference of the $100,000 to their taxable value. Therefore, the taxable value of the replacement property will be $400,000 (original tax value transferred, $300,000, plus the excess market value of the replacement property, $100,000).
2. However, if the replacement property’s market value is less than or equal to the market value of their current primary residence, then the taxable value will transfer to the replacement residence with no adjustment needed. Meaning, if Joe and Susie find their replacement property is $1,000,000 or less then they will transfer their current property tax values from their original home of $300,000 to the new primary residence due to Prop 19.

For transfers between parents and children, and grandparents and grandchildren the rules work a little differently. To qualify and transfer the original taxable value of the parents or grandparent:

• The home must be eligible for the homeowners and disabled veteran’s exemption with the exemption applied for within one year of transfer or purchase.
• The assessed value of the new home when purchased or transferred must meet a value test. The value limit equates to the parents or grandparents’ taxable value at time of transfer plus $1 million. Any amount over the value test limit is added to the taxable value for the child or grandchild.
• The child or grandchildren are required to maintain the home as their primary residence for the remainder of their life.  If they turn the property into a rental or live in another home, that will trigger a tax reassessment on the property creating larger property taxes.

Example for value test:  Lauren and her daughter Lisa live together in Los Angeles. Lauren bought their home in 2000 when her original taxable value was $200,000. Due to Prop 13 Lauren’s property taxes have been capped on increasing and being reassessed at the properties market value. Lauren wants to transfer the home to her daughter Lisa. Prop 19 will allow them to transfer Lauren’s current taxable value of her property to Lisa if it passes the value test. The original taxable value of Lauren’s property, $200,000, is referred to as the Factor Based Year Value (FBYV). Prop 19 allows for the value limit to equal the FBYV of $200,000 plus $1 million dollars.

1. Over the years, the market value of Lisa’s home has increased to $900,000. Since the market value is under the value limit of $1.2 million ($200,000 FBYV + $1,000,000), Lisa will receive the original taxable value as Lauren with no additional property taxes.
2. Let’s say the market value increased to $1.3 million. Since the value limit is $1.2 million, Lisa will have to add the difference of $100,000 ($1.3 million – the value limit of $1.2 million) to the original taxable value. Thus, the new taxable value for Lisa would be $300,000 ($200,000 original taxable value + $100,000 difference).

As you can see, the benefits of Prop. 13 and Prop. 19 play hand in hand and are great for many California taxpayers, and especially advantageous for seniors, severely disabled, disaster victims.

Prop 19 replaced Proposition 58, which provided a more favorable transfer of real estate from parent to child. The changes are more restrictive for gifting property to children and grandchildren (i.e., primary residence requirement, value test, and non-primary residence elimination). 

If you own a home in California with a low tax basis and would like to keep the property in the family, talk with us and your estate planning attorney. If you would like to contact us, please speak with your advisor or you can reach us at financialplanning@bfsg.com.  

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By: Paul Horn, CFP^®, CPWA^®

You do not have to turn on the news to know that many in the world are hurting. There is a greater need for charitable giving today than any time I can remember and there are so many different causes that need support. The most common way to make a charitable gift is with cash and this works fine for smaller gifts (think one-time small charitable donations) but for larger charitable gifts there may be better alternatives to consider.

Gifting Appreciated Assets

There are several tax benefits of gifting stock instead of cash. We are amidst the longest bull market on record, and many have large gains in their taxable accounts. If you gift appreciated stock you don’t have to pay taxes on the gains of the stock and you still get credit for the total gift if you itemize your deductions. Let us take a look at an example below:

You can see in this example gifting appreciated stock instead of cash can save the person over $8,000 in taxes. Even for smaller gifts, this strategy can still be very effective!

Gifting From Your IRA

Did you know you can make gifts out of your IRA? This strategy is called a Qualified Charitable Deduction (QCD) and often is better than gifting cash. The IRS allows QCDs up to $100,000 per year and the amount you gift decreases your Required Minimum Distribution (RMD) by the same amount. For example, if you have an RMD of $20,000 for the year and use a QCD of $12,000, all you are required to take for the RMD is $8,000. You do not pay taxes on the QCD amount (in this example $12,000).    

If you are 72, own an IRA, and donate to charities, QCDs may make sense for you. If you would like to learn more about charitable gifting please check out our webinar. As always please consult with us or your CPA before implementing these or other strategies.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s web site or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please see important disclosure information here.

California is about to go through a dramatic change to real estate and property tax assessments with Proposition 19 (Prop 19) going into effect on February 16, 2021. Prop 19 replaces Proposition 58 (Prop 58), which has provided a favorable transfer of real estate from parent to child. It is important to understand these changes to see if you need to make any immediate changes to your real estate holdings before Prop 19 takes effect.

How do current laws work?

Currently, real estate with a low tax basis can be transferred during the parent’s lifetime or at death to a child and the child keeps the low basis and it does not trigger a tax reassessment. This rule applies to both primary residences and rental properties. The kids can live in the home or turn it into a rental and maintain the same low taxes the parents enjoyed. This transfer has unlimited value for a primary residence and “non-principal residence” (rentals or other homes) is limited to $1 million of assessed value per person. A married couple can transfer $2 million in assessed value. This means a property worth $3 million but a tax assessed value of $750,000 can be transferred to the children.

What changes with Prop 19?

Under Prop 19 any primary residence gifted to children will require the children to maintain that as their primary residence for the remainder of their life. If they turn the property into a rental or live in another home, that will trigger a tax reassessment on the property creating larger property taxes. The exemption amount is lowered to $1 million and applies ONLY to primary residences. The non-primary residence home exclusion is eliminated and will trigger a tax reassessment.

Examples:

1. Primary Residence

Assume you bought a home twenty-five years ago and today it is worth $2.4 million but has a tax assessed value of $400,000. Under current law, the home can be transferred to your children during your life or at death and they will maintain the tax basis of $400,000 and can live in the home or turn it into a rental.

Under Prop 19, once the home is transferred to your children, one of them must live in the home immediately and maintain it as a primary residence indefinitely to avoid a tax reassessment. Since the home is worth more than the $1 million new exemption, it would trigger a new tax assessed value. The new tax assessed value would be $1.4 million ($2.4 million value – $1 million exemption) instead of $400,000.

2. Rental Property

Assume you bought a rental property twenty-five years ago and today it is worth $2.4 million but has a tax assessed value of  $400,000. Under current law, the home can be transferred to the kids and they maintain the $400,000 tax assessed value since a couple can use exemptions up to $2 million in tax assessed value.

Under Prop 19, the “non-principal value” exemption is eliminated so it would trigger a large tax assessment and the kids do not retain the $400,000 tax assessed value.

What should you do?

If you own a home in California with a low tax basis and would like to keep the property in the family, talk with us and your estate planning attorney today to explore if you should consider gifting the property before the February 16th deadline when Prop 19 takes effect. If you would like to contact us, please speak with your advisor or you can reach us at financialplanning@bfsg.com.