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Multi-family buildings are a common form of properties that one generation uses an investment vehicle to pass on to the next. This intergenerational real estate is commonly viewed in a way that makes mortgages on them as appealing as mustard on ice cream. The closer to debt-free, the more attractive it appears, after all, it is an investment for the future. But little or no debt is not the most prudent position, especially when the property makes up a significant part of the estate. Because, absent sufficient liquidity and/or insurance, the building may have to be sold or financed to pay the estate taxes. And the timing is dictated by estate tax deadline.
By placing a mortgage that has a conservative loan-to-value on the property, planning can save millions of dollars in estate tax. Insurance can be purchased with the cash from the financing and placed in an Irrevocable Life Insurance Trust (ILIT). The proceeds of the death benefit paid to the ILIT is outside the estate and therefore not taxable.
If the property is owned by more than one entity, there are other ways to take advantage of the tax code and conservative financing can enhance them even more. When gifting a non-controlling interest in multi-family property there is as much as a 40% discount on the value for gift tax purposes. If, before making the gift, the property were re-financed, the gift-tax value of the property would be reduced. So, if each of two siblings had a 50% interest in a $10,000,000 multi-family property that had $2,000,000 in current mortgage, each would have an interest valued at $4,000,000. A gift of each interest in the property would be valued for tax purposes at $2,400,000. By increasing the loan to $5,000,000, they each would get $1,500,000 in tax free cash and their share of the value would be $2,500,000. A gift would then be valued at $1,500,000, $900,000 difference. They would have had to agree on the financing, but not the gift. And, because the financing is a conservative 50%, they get the best rates and terms.
Funds can also be used for other purposes:
- Diversify assets
- Long Term Care Insurance (e.g., fund an annuity to pay the premium)
- Key Man insurance
- Create Family Trust
- Buy-out insurance to simplify future ownership
- Improve cash flow by lowering rate
- Property enhancement
- Locking in today’s low rate for longer period
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