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GIFTING / FAMILY PARTNERSHIP BROCHURE

This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal adviser.

If your net worth is over $600,000 [$1.2 million for a married couple] you can reduce future death taxes by giving property away today. This technique is greatly underutilized for two reasons:

Together, a Husband and Wife can give away $20,000 per year to each of an unlimited number of recipients. However, if you give a check to your son, he can then spend it, waste it, get sued, get divorced, or die and leave the gift to his wife or other beneficiary.

A better technique is to give something they cannot spend, sell, give away, or lose in a divorce. Something valuable, which does not cost you cash out of your pocket. Something which allows you to retain control.

The answer: real estate. You can give away real estate without giving up liquidity, without losing control, and without risk.

However, if you deed a child even 1% of a property he can sell it, mortgage it, or give it to his wife. He can even sue you to force a sale of the entire property (a lawsuit for Partition).

To prevent this, it is possible to form a Family Partnership. You give your descendants non-voting Limited Partnership shares. You retain 100% control as General Partner. You can never be outvoted, even if you have only 1% ownership.

Gifts up to $10,000 per donor, per year, per recipient, are free of all taxes. No taxes to the giver; no taxes to the recipient.

Each year a Husband and Wife can give $20,000 (of equity) of real estate to each child and grandchild. If you own property worth $800,000 of equity, you can give 2.5% ($20,000) Limited Partnership shares to each recipient.

You can do this every year, although the annual percentage given will (hopefully) diminish as the value of the property grows. When the property value grows to $1 million, 2% per person is all you can give tax free.

Prop 13

Property taxes do not increase for transfers of real estate into Partnerships or for transfers of Partnership shares until 50% or more has been transferred. [Expert advice is necessary to structure the formation of the Partnership and subsequent gift transfers of Partnership shares to avoid reassessment (which can be triggered if not done exactly right).]

Annual Tax Returns

Partnerships require annual Tax Returns. The State of California imposes a minimum tax of $800 per year for a Limited Partnership (you would be the managing General Partner).

If the donor is willing to give up control (perhaps to the oldest child), the Partnership can be a General Partnership, thereby saving the $800 annual tax imposed by the State of California, which tax applies only to Limited Partnerships.

Each Partner gets a K-1 and reports his proportional share of income, expense, and depreciation on his own Income Tax Return. The Passive Loss Rules apply and may limit deductibility of losses to passive Partners.

This may cost you some tax deductions you had before you gave away a piece of the property, or cause reallocation of taxable profits to your descendants if the property has taxable income.

GIFTS TO MINORS

There is one easy way to make effective gifts to minors: to a parent, as Custodian, under the California Transfers to Minors Act. In California, you may specify that the Custodianship will last until age 21, when the minor gets the balance.

Custodianships are self-created, without any lawyers, Court involvement, documents, or other headaches.

However, if the donor is the parent, assets subject to Custodianship by the parent are part of the parent's taxable estate at his death.

If the parent is the donor another person should be Custodian for any gifts to the minor.

A better way is to establish a Minor's Trust with someone other than the parent as Trustee, if the Parent is the donor of the gift.

RETAINED CONTROL

As Managing General Partner, you retain full control, even if your ownership percentage diminishes down to 1%.

You decide when to sell the property. You decide how to reinvest the proceeds. You control everything.

Cash Distributions

Each Partner is entitled to a proportional share of actual cash distributions. However, the General Partner (you) retains the right to build an appropriate reserve for business purposes. The amount of the reserve is subject to your control, as is the decision on how to invest it.

However, if you desire a cash distribution from the property, and do not want to make distributions to other partners, the only way is a taxable management fee to yourself.

NO STEP-UP IN BASIS

Inherited property receives a step-up in basis to the date of death value. Lifetime gifts do not receive a step-up in basis.

If you own a property with an initial cost of $100,000, after several years you may have claimed $25,000 of depreciation. Your tax basis therefore is $75,000.

If you sell for $160,000, your taxable profit is $85,000. [Economic profit is $60,000, plus depreciation `recapture' of $25,000.]

Instead, if you hold the property and die when it is worth $160,000, the property is subject to death taxes (at your highest marginal tax rate). However, your children who inherit get a free step-up (increase in their income tax cost) to the date of death value, $160,000. They can sell it later and they pay income tax only on the profit above $160,000. Or they can start depreciating it all over, based on their cost of $160,000.

However, if you make lifetime gifts, your children never get a step-up in basis; they did not inherit the property. Their tax cost is the same as yours. When they sell it (unless they do a tax free trade), all the profit is subject to income tax.

DISCOUNTS

You may give more than $10,000 face value of property, because a non-voting minority ownership of real estate subject to another person's control is worth less than face value, due to lack of voting power, control, and limited marketability of a Partnership share.

Appropriate Types of Real Estate

A Family Partnership works best with investment property. It is NOT appropriate for a personal residence (the beneficial tax rules for a residence do not apply to a Partnership).

A Family Partnership may enter a tax deferred exchange (§1031), but Partners may not §1031 their individual shares. If all of the Partners want to do a tax deferred exchange the Partnership may, but if some Partners want to cash out, the others cannot easily avoid taxation.

For more information about Limited Liability Companies

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