Preferred Partnerships for Real Estate Estate Planning

Preferred Partnerships for Encumbered Real Estate A Quick Look into the Upcoming Notre Dame Tax and Estate Planning Institute By: Jerome Hesch, Esq. and Martin M. Shenkman, Esq. 1

General Disclaimer The information and/or the materials provided as part of this program are intended and provided solely for informational and educational purposes. None of the information and/or materials provided as part of this power point or ancillary materials are intended to be, nor should they be construed to be the basis of any investment, legal, tax or other professional advice. Under no circumstances should the audio, PowerPoint or other materials be considered to be, or used as, independent legal, tax, investment or other professional advice. The discussions are general in nature and not person specific. Laws vary by state and are subject to constant change. Economic developments could dramatically alter the illustrations or recommendations offered in the program or materials. 2

What is a Preferred Partnership Freeze A preferred partnership freeze ( PPF ) is a reorganization of a partnership into preferred interests and common interests. The preferred interest is like a bond so all the appreciation in value must be allocated to the common interests. Senior generation retains the preferred interest and disposes of the common interest by gift or sale to an irrevocable trust. The frozen preferred interests is an asset in the Senior s gross estate and qualifies for a step up in basis at death. The freeze is that the common interest with the potential for all appreciation is in an irrevocable trust outside Senior s estate. 3

Encumbered Real Estate Pre- Death Facts: Market Value: $50M. Basis: $5M. Mortgage: $40M. Equity: $10M. Predicted Future Value: $80M. Objective: Shift $30M of appreciation outside Senior s estate to an irrevocable trust. Senior contributes $1M of cash for the common interests. Senior contributes encumbered real estate for a $10M preferred interest. Gift or sale of common interest to an irrevocable trust. (doesn t always have to be a grantor trust). 4

Encumbered Real Estate Post- Death Preferred interest equity $10M included in Senior s gross estate. Senior dies. Only the preferred is subject to estate tax. What is the estate s basis in the preferred interest? Common interest at death is worth $31M ($1M contribution + $30M appreciation). Key the preferred interest has $50M of gross value, $40M of debt, $10M of equity. The estate s income tax basis in the preferred interest at death is $50M. Under Crane v. Commr. It is the underlying value of the property. The estate tax value included in the estate is $10M [$50M value less $40M debt]. Basis was $5M step up of $45M. The partnership income tax rules require that the tax attributes stay with the partner contributing. You cannot shift the liabilities or built-in gain to the common partnership interests. 5

Income Tax Advantages For estate tax cost of $4M on $10M of equity Senior s estate obtained a $45M basis step up. $45M of depreciation deductions saves income taxes on $45M of ordinary income. 40% of $45M = $18M of approx. income taxes saved. 6

Additional information Jerome Hesch, Esq. Jhesch62644@gmail.com For information on the 48th annual Notre Dame Tax and Estate Planning Institute go to: http://law.nd.edu/estateplanning 7