By Victor Mizzaro, CPA, Partner
Niles Citrin, CPA, PFS, Partner
Richard Zendel, Principal
and Matthew Bonney, CPA, Partner
For real estate family dynasties, 2012 brings about a particular matter that they must address — to gift or not to gift?
Transferring ownership and control to the next generation often starts a chain reaction of events that involves carefully planned financial executions.
During this process owners/managers place a heavy emphasis on tax and estate issues and overlook succession planning as a piece of the puzzle. At times, when a CEO is ready to turn over the reins of their enterprise, many challenges and emotions can come into play.
Managing this process, successfully, requires anticipating the strategic direction of the business and its needs going forward, determining who is best qualified to meet those needs, what the timetable for the transition should be, and retaining the talents and loyalty of those who are passed over.
This task is all the more difficult for family-owned businesses. At a time when dispassionate, strategic thinking is essential, the environment is usually highly charged due to the intertwined personal histories of family members.
Having a family dynamics coach on the advisory team can alleviate some of the strain in this decision-making process and help the family work through the emotional issues that are often found in family businesses. These specialists have extensive experience working in family business situations and in helping to untangle the wide range of emotional issues from the business issues that need to drive the successful transfer of leadership.
In other words, they help everyone keep their eye on the ball.
Typically, family ownership of real estate companies tends to include both active and passive members. This constraint can often complicate the succession process, particularly if plans include transferring ownership to multiple generations and the number of family members involved grows. Of course, one must also consider what effect the choice of successor will have among the other executives in the company and the other members of the family.
If an outside CEO is being brought in, the transition from “family-run” to “family-owned” will bring its own set of issues.Once the new ownership and control structure of the company has been planned out, it is essential to establish strong governance. Clearly define the rights and responsibilities of passive versus active owners, as well as non-owner management.
Clear boundaries allow each party to fulfill their role without the impediment of ambiguity, something that is in the best interests of everyone involved.After a tentative succession plan has been outlined, then it is time to look at the tax and estate planning issues involved. While these considerations should not determine the succession plan, they must be factored into it. The combination of the high value and low liquidity of real estate can create a significant estate tax burden.
The 2010 Tax Relief Act allows individuals to make gifts valued at up to $5.12 million (in 2012) to another person, tax free. Married couples can gift up to $10.24 million. More importantly, if the gift is of real estate, the figure is based on the valuation of the gift, that is, the fair market value less discounts for illiquidity and for lack of control (such as in a partnership).
When those discounts are applied to the fair-market valuations, one will find that real estate worth considerably more than $5.12 million can be gifted to heirs with no cash outlay. However, this provision of the tax law is currently set to expire on December 31, 2012. Moreover, valuation discounts for transfers between related parties — which can significantly reduce the taxable value of a gift — may be eliminated by future legislation.
The certainty of the current favorable gift tax rules, combined with the uncertainty of future regulation, make this an “act now” time to adopt an aggressive gifting strategy.
In case you need further encouragement, gifts in excess of the $5.12 million deduction currently carry a tax rate of 35 percent (on the excess), that rate is scheduled to revert to 55 percent in 2013. Given the opportunity this year presents for gifting real estate, it is highly recommended that you think twice before resigning to the idea that you don’t need to gift any more than you may already have.
Additionally, you owe it to yourself and your legacy to address succession considerations throughout this gifting process.
Finally, share your thoughts with your advisory team … before December!