Scenarios for Tax, Gift & Estate Planning
In my last blog, I shared that I thoroughly enjoy working on unique scenarios where a business valuation is needed. A business valuation is often part of a well-thought-out business plan to protect business interests and reduce tax liability.
This blog discusses three scenarios where residential properties need a ‘business’ valuation. Why would a business valuation be needed for a residential property? Below I highlight two common scenarios and one tax planning strategy that I am starting to see more frequently:
Scenario 1 – Income Producing Investment Property
Individuals purchase residential real estate as an investment and to produce income via renting the property, have the property held in an entity, commonly an LLC or a trust, as part of their tax planning strategy. Historically, many invest in residential real estate as an investment strategy, sometimes having fractional shares held in a trust with the children being the beneficiaries. In this scenario, a business valuation is needed to determine the business value (e.g., of the entity) to then calculate the value of each fractional share. The property is rented out via traditional real estate channels or leveraging such services as VRBO or Airbnb as examples.
Scenario 2 – Vacation Property
Throughout New England and across the globe, there are many vacation homes that have been owned by families for generations. Many of these homes are also income producing properties that may be owned by a family (with fractional shares) or a single party. When the family or single party owner chooses to have the income producing property held in a trust or LLC, a business valuation is need and if multiple owners, the value of each fractional share is determined.
Often the death of a shareholder will trigger the need to recalculate the value of the fractional shareholders; requiring a business valuation to be prepared first to then recalculate the value of each fractional share.
My previous blog explained the process for a business valuation that includes real estate and below is an overview of that process.
To explain this scenario, let’s assume at the time of death of one of the shareholders, there were five shareholders in the property. Over the years, the extended family includes grandchildren and it has been determined that grandchildren over the age of 25 are to be granted shares in the vacation property. The valuation of the entity is determined and then the value of the fractional shares is recalculated, to include the adult grandchildren as shareowners.
Scenario 3 – Primary Residence in an Entity
The above two scenarios have been common for years. An emerging estate tax planning strategy being implemented by high net worth individuals includes putting their primary residence into an entity. The entity typically includes other assets with the property leased back to the high net worth individuals who pay rent. A business valuation is prepared to determine the value of the entity, incorporating the real estate appraisal prepared by a real estate professional. The value of fractional shares are then determined by Merrimack Business Appraisers. While less common than the other two scenarios, we are seeing more business valuations where high net worth people are working with their professional advisors to protect wealth and pass assets to the next generation.
Overview of the Valuation Process for Income Producing Real Estate
It may seem odd to describe preparing a business valuation for residential real estate, but as income producing property, the residence has been put into an entity as part of a tax planning strategy.
The business valuation work we develop determines the value of the real estate entity and the fractional shares when the entity is initially formed, and again when there are changes to the number of shareholders. In both cases, a business valuation is needed.
My valuation work accounts for whether the property is income producing property with rental or lease income. To develop the business valuation of the real estate, I will leverage the real estate appraisal completed by a real estate professional. The balance sheet data will be updated to replace the original cost of the property with the current real estate appraisal; then I deduct any liabilities to determine the equity value. Based on the number of fractional share owners, I calculate the value of the fractional shares for the owners, which may go into trusts.
Conclusion
There are effective tax planning strategies to transfer wealth to the next generation. As you work with your professional advisors to plan and implement such strategies, keep in mind the need for a business valuation. A common misperception is you only need a real estate appraisal. With residential property held within a business entity, you need both a real estate appraisal and a business valuation expert to then calculate the total value and the fractional shares. Get the real estate appraisal completed and we can then take it from there.
Contact us to assist you in determining the value of the residential property and the fractional shares as part of implementing effective tax planning strategies.
When Values Matter
