Assets Worth Less Right Now?  Consider This Tax Strategy


We all buy assets – property, equipment, companies – for many  different  reasons.  As a general rule, we  hope they appreciate in value.    When the value drops, as many values have in the current environment, it probably feels like bad news.

But  there’s a way to turn that drop in value into a  benefit for your family.   Gifting or selling  those assets to family members, or to trusts for their benefit, can create potential for  a tax-free wealth transfer.

And now might be a great time to do so, for two reasons.

When you transfer assets to family members, or to trusts for their benefit, you essentially “freeze” the value of those assets for estate and gift tax purposes.   If the assets appreciate in value after being transferred,  the appreciation generally escapes estate or gift tax, and your  heirs  benefit.   So  if you  transfer  assets to family members  when values are depressed – which many are now – usually there is  greater potential for a tax–free wealth transfer.

Moreover, for certain estate planning techniques, such as transfers to grantor retained annuity trusts (GRATs) and sales to intentionally-defective grantor trusts (IDGTs), the gift component, if any, is determined using current interest rates – specifically, the applicable federal rate (AFR) or the 7520 rate.   The rates for July and August 2020 are at or near all-time lows. If, going forward, investment returns for the transferred assets outpace these rates, you can potentially transfer wealth to family members free of estate and gift tax.

Of course, this isn’t as simple as wrapping a birthday gift.  You can’t just say your assets are worth less; appropriate valuations are necessary, and the IRS often audits the value you claim.  Therefore, for difficult to value assets, such as interests in closely-held businesses, utilizing a certified valuation professional may be  essential.  In most cases, if you obtain a valuation from a qualified appraiser and disclose it to the IRS on a gift tax return, the IRS has only three years to contest the value.  Without such a valuation, the IRS potentially could contest the value many years later, even after your death, when relevant information is more difficult to obtain and adverse tax consequences and other complications can result.

3 factors in valuation calculation

Business valuation is a complex discipline with many rules and standards. Certified valuation professionals must consider various factors that affect the value of your business while ensuring they comply with IRS standards.  Since long term financial projections may not be easily quantifiable and can be uncertain during these times, a thorough analysis needs to be applied to the risk associated with the business, which helps to calculate the value.

Three important factors go into these valuation calculations:

  1. Projected earnings – There may be a risk to your ability to continue to generate cash flows at historical levels.
  2. Marketability – For minority interests, discounts for lack of control and lack of marketability may have increased due to liquidity issues in the current market
  3. Capitalization rate – This is a measure of risk used to calculate the value. A  cap rate may increase due to higher risk – and thus value may decrease.

These uncertainties and many other factors are accounted for in our valuations and may reduce the estate or gift tax value of the interest.

3 types of assets to look at

There are three categories of assets you might consider transferring in the current depressed market.

  1. Companies are the first category of assets.  Many of the factors that cause a decrease in value are in play right now, and valuation analysts will look for evidence.  If your business has closed, even temporarily, the value may be lower.  Social distancing requirements that limit the number of customers in a store or restaurant can decrease the value.  For manufacturers, these limitations may have decreased production, which could impact value.
  2. Tangible assets, the second category,  include equipment or real estate.  While residential real estate values may not have  changed much, if you own commercial real estate with tenants, the value will be affected by your leases.  Many landlords have lost a quarter of their tenants!   Have you lost tenants, made significant rent concessions, or do you have many tenants who are struggling to pay their rent?  If so, your asset value may have decreased.
  3. Marketable securities are the final category of assets.  The value of public stocks, treasury notes, and other market instruments has been volatile; a decline in value may have occurred.

If you own assets that have decreased in value, a variety of planning techniques may turn this downturn into a tax benefit – for yourself and your heirs.

Peter Smith, CVA, is a Forensic, Advisory and Valuation Services Principal at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.

Scott Goldberger, JD, CPA, is a Estate & Trust Principal at Kaufman Rossin, one of the Top 100 CPA and advisory firms in the U.S.

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