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Trusts

Lead Trusts

Lead Trusts Story:

Charles, age 76 and a widower, owns income-producing residential buildings currently valued at $7 million. The buildings generate a net income of $700,000 (or 10% of current value). Furthermore, based on real estate values in the area in which the buildings are located, Charles anticipates that the buildings’ value may grow to $15 million in 12 years. He would like his children to inherit the buildings without the burden of either gift or estate taxes. He would also like to make a significant gift to the St. John’s. The donor has a gift and estate tax exclusion of $5,950,000, with the first $5,950,000 going to his children tax-free, but any amount over that is taxed to Charles at 45%.

From a tax-planning standpoint, Charles has several options:
  1. He can give the building now to his children, giving them immediate access to the annual income and generating a taxable gift tax of $1,050,000 and a tax of $472,500, which he has to pay.
  2. He can hold the building until his death (actuarially estimated in 12 years), retain the income for himself during his lifetime, watch it grow in value to $15M, and give it to his children through his will, generating an estate tax of over $4,000,000 (assuming the current $5.95 million estate tax exemption per person remains in effect).
  3. He can place it into a 12-year Charitable Lead Trust (CLT), granting an annual gift to SJS of $490,000 (7% of current value), take advantage of his current gift tax exclusion and the gift tax deduction provided by the CLT to eliminate both the current gift tax and the future estate tax, transfer the entire estimated $15,000,000 in real estate in 12 years to his children with no gift or estate tax at all. In the meantime, he has also made gifts to St. John’s totaling $5,880,000.

Lead Trust – How it works:

Lead trusts are essentially the opposite of remainder trusts. The donor establishes a trust with cash or assets while St. John’s receives distributions for a period of years, with the assets reverting to the donor or members of the donor’s family at the end of the trust term. This works well for donors who are not dependent upon the yield from the assets in the near term, but  would like to preserve family control over the assets in the long term and avoid gift and estate taxes that a direct transfer to family might otherwise generate. Lead trusts, like remainder trusts, are flexible but complicated and require the help of an estate or tax attorney to draft and manage.

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