Small-business succession:  low rates and real estate values offer new way to reduce estate and gift taxes

Small-business owners who want to pass down their business to the next generation and reduce gift and estate taxes have a new way to do it—thanks to today’s depressed real estate market and low interest rates, says Jonathan M. Bergman, CFP, VP of Palisades Hudson Financial Group.

Here’s an example how it works.

The business owner, Mr. Jones Sr., owner of Jones Restaurant, sells the land and buildings to his son, Jones Jr.  Junior signs a promissory note—for instance, a 9-year interest-only note at 2.82 percent, the lowest rate allowed by the IRS as of February 2010.

As the property owner, Junior now charges the restaurant rent, which should be a deductible business expense for the restaurant.  After paying annual interest, Junior can use the excess cash to pay down the debt.

Nine years pass.  Now Junior can repay the note, refinance it with Senior or another lender.

“Given today’s depressed commercial real estate values, it’s pretty likely the building and land will be worth a lot more then,” Bergman says.  “The appreciation will occur outside of Senior’s estate, reducing potential gift and estate taxes.”

Even conservative assumptions produce substantial savings.  For example, suppose the property is worth $2 million and it appreciates at 5 percent a year.  The rent is pegged at 7 percent, or $140,000 a year.

At the end of nine years, the property is worth $3.103 million.  Junior repays a portion of the principal on the last day of the loan.  Subtracting the remaining $1.248 million debt, Junior’s net asset is now worth $1.855 million—the total amount transferred without any gift taxes.  And since the property is out of Senior’s estate, it won’t be subject to the eventual estate tax.

The longer the term, the greater the appreciation and tax benefits.

Given the uncertainty about the estate tax—temporarily at zero for 2010 and scheduled to be reinstated at its old level in 2011—is it worth the effort to start such a program now?

Bergman says it is.   While it’s impossible to predict exactly what Congress will do, no one expects the estate tax to remain at zero past this year.

“Low interest rates and low real estate values give forward-thinking business owners a rare opportunity to do some effective, creative planning today,” he says.

About Palisades Hudson

Palisades Hudson Financial Group is a fee-only financial planning firm headquartered in Scarsdale, NY.  It offers estate planning, insurance consulting, trust planning, cross-border planning, business valuation and appraisal, family office and business management, and executive financial planning.  Its sister firm, Palisades Hudson Asset Management, is an independent investment advisor with about $950 million under management.  Branch offices are in Atlanta and Ft. Lauderdale.  Website: www.palisadeshudson.com

Contact:  Henry Stimpson, Stimpson Communications, 508-647-0705, Henry@StimpsonCommunications.com