You've found the perfect corner location for your retail business. Or maybe you've transformed a beach cottage into your dream vacation home. What does the future hold for these assets? Will you one day pass them on to your children or grandchildren? Such decisions shouldn't be taken lightly. There are several options you'll need to consider to transfer these assets effectively and cost-efficiently. It's beneficial to start the process early and in consultation with your wealth and tax advisors.
Transfer strategies and your estate plan
Because real estate — whether business or personal — is typically one of your more valuable assets, the way you approach its transfer can have a tremendous impact on your wealth and your estate. If you decide to transfer your property to family members, there are tax issues to consider and several strategies that may be able to help you make the transfer efficiently and effectively, keeping in mind potential estate tax concerns down the road.
When it comes to estate planning, often "the goal is to find assets within your net worth that you are willing to do something with, such as give to your children, to help minimize estate taxes," says Danielle Louton, Senior Wealth Planner at Wells Fargo Private Bank. "It's about being efficient in getting assets to your beneficiaries."
Gifting equity in a home is a popular strategy for parents who want to remove an asset from their estate while keeping the property in the family. Gifting equity allows you to pass along the asset at its current value. This can be helpful to your estate if you expect the property to continue to appreciate. You can even continue to live in the home after you gift it through a qualified personal residence trust, says Louton. This is also an option for vacation homes that families want to keep for future generations.
The trust specifies the number of years that the couple retains the right to use the home. The strategy freezes the value of the property, helping to limit estate taxes. At the end of the term, assets of the trust pass tax-free to the beneficiaries.
If the couple outlives the term, the value of the assets is excluded from taxable income. On the other hand, the tax benefits disappear if one of the grantors dies before the end of the term.
As a result, the health, life expectancy, and family longevity of the grantors dictate the term. "We want you to survive that term so the asset is no longer on your balance sheet," Louton says.
Other options for transferring real estate include forgiving interest and payments on loans you make to family members and, less frequently, gifting of a down payment, says Tammy Robbins, a Senior Wealth Planning Strategist at Wells Fargo Private Bank. Your wealth and tax advisors can help you determine the most effective strategy for you and your family for both the short and long term.
When it comes to estate planning, often "the goal is to find assets within your net worth that you are willing to do something with, such as give to your children, to help minimize estate taxes." — Danielle Louton, Senior Wealth Planner, Wells Fargo Private Bank
More to consider when a business is involved
Robbins specializes in business real estate assets, including working businesses like farms. Often business owners fail to consider the real estate component of transferring their business to the next generation. This is especially critical right now, as baby boomers own six out of 10 businesses with annual revenues between $25 million and $100 million, Robbins says, so the coming transfer of wealth — including businesses and property — means planning is important.
Only one-third of businesses survive the transition from one generation to the next, she adds, and often that failure can be traced to a lack of effective planning.
"Most families want to keep the business in the family," says Robbins. "However, there are challenges that you'll need to address and family dynamics to consider. There are many pitfalls that can occur."
One of those challenges is the emotional connection owners feel to their business or its property. This can be especially prevalent in farms, which often have a deep history in a community.
"In working with our agricultural families, we often find that keeping their property in the family blood lines for generations to come is a common goal," Robbins says. "Often the businesses are in smaller communities so the family name, the family's legacy, is typically very important for business owners."
These extra emotional challenges make planning even more important. Robbins says business owners preparing for retirement should answer a number of questions, starting with how much income they'll need to draw from their companies, says Robbins. That helps determine how to divide the equity. Try to keep emotions on the sideline as much as possible when making decisions.
Moreover, even if the owners are willing to turn management over to their children, are they willing to give up control as well? Sometimes children think they're ready to run the family business, but their parents don't agree. In some cases, children want to leapfrog experienced managers and take charge from their parents. Does it make more sense to sell the business to an outsider buyer?
Early planning and conversations between parents and children can mitigate these potentially uncomfortable situations, Robbins says.
"There is blood- and sweat-equity tied to these emotions, so doing this type of planning in the 11th hour makes it challenging," she says. "Keeping family harmony at the Thanksgiving table is important."