Archive for February, 2012

When most of my clients hear the words “estate planning,” they first think about avoiding estate taxes. However, under current law, federal estate tax (maximum rate of 35%) does not kick in unless someone passes away with more than $5 million in assets, and the State of Washington death tax (maximum rate of 19%) does not get triggered unless the estate value is more than $2 million. I certainly have clients that will fall within this taxable range (especially when taking into account life insurance – which many people fail to consider), but even for those clients, estate planning is more about passing their assets to their children, grandchildren, other relatives
and/or charities in a responsible and organized manner.

For clients that are real estate investors, estate planning is almost always intertwined with structuring their affairs to avoid current liability concerns and to allow for smooth management/ ownership transition in the event of disability or death. In other words, avoiding taxes at death is normally a minor issue in comparison to other estate planning objectives.

In a general sense, there are two basic methods for passing assets at death: (1) a Last Will and Testament (“Will method”); and (2) a Revocable Living Trust (“Revocable Trust method”).  Under the Will method, a deceased client’s “probate assets” will pass according to the terms of the Will. Probate assets include real estate, personal property (e.g. jewelry, cars, household items, etc.), bank accounts, business entity ownership (e.g. LLC membership units) and other property that does not pass according to a “beneficiary designation form” (e.g. retirement plans, life insurance, etc.). The wording of a Will can pass assets directly to heirs (e.g. “all of my assets to my spouse, and if he/she is deceased, to my children equally”) or can pass assets into a trust (e.g. “all my assets to my Family Trust to be administered as described in Section 8 of this Will”). The Will also names individuals that become very important at death, for example: the “Guardian” is the person who will care for the client’s minor children if both spouses have passed away; the “Personal Representative” is the person who will act out the wishes of the client based on the terms of the Will; and the “Trustee” is the person who will manage the trusts (on behalf of the beneficiaries of the trust) created under the Will. In general, the first time a person should start thinking about creating a Will is when they own significant probate assets (e.g. first home) and/or have minor children. A Will can be amended at anytime, and clients often make changes as they age and their family situation and/or assets evolve.

One of the downsides of the Will method of estate planning is that some of a client’s assets will pass through “probate” at their death. Although this legal process is relatively painless under Washington law, there are several downsides, including: (1) the deceased person’s Will becomes public record, which has the potential to raise hostility within the family, particularly if some family members have been excluded from the Will; (2) the probate process can take along time and can cost thousands of dollars to complete.

The Revocable Trust method involves creating a Revocable Trust and transferring assets into the trust. The potential benefits of this method include: (1) assets held within the trust at death will pass directly to the beneficiaries of the trust without going through probate; (2) although more expensive to initially setup, the Revocable Trust method can save probate costs at death (note: this benefit is the primary motivator for the widespread use of Revocable Trusts in states like California, where the probate costs are much higher than in Washington); (3) if the client holds real estate in several different states at death, multiple probate proceedings can be avoided (note: most states require a separate probate proceeding if real property is held within their jurisdiction  – unless the property is legally owned by a trust).

In most instances, I do not recommend the use of the Revocable Trust method for clients that are relatively young (e.g. 30s or 40s) unless the client owns property in multiple states. The reason is that Revocable Trusts not only need to be drafted properly, but also need to be funded and maintained correctly. I have had many clients tell me that they have a Revocable Trust in place, only to find out that their former attorney did not assist them in legally funding the structure. A Revocable Trust that is never funded will not result in the benefits described above.

Several other reasons why the Revocable Trust method is not always the best for some clients include: (1) if real estate held within the trust is sold and new property is acquired, the trust needs to remain appropriately funded (I have seen many situations where the new property is never legally placed into the trust); (2) the eventual probate cost savings do not outweigh the cost to create, fund and maintain the trust structure. However, for clients in their 60s or 70s with relatively fixed assets, the Revocable Trust method can make a lot of sense.

Regardless of the estate planning method used, I always recommend that my clients also have a Healthcare Directive and a Power of Attorney in place. A Healthcare Directive allows a client to decide what they would like their doctors to do if they are ever in a “permanently vegetative state.” This document can help relieve the client’s family of the difficult decisions that can arise in this very specific situation. The Power of Attorney document allows the appointed “Attorney-in-Fact” to make financial and healthcare decisions on behalf of the client if the client is ever incapacitated (whether temporarily or permanently) or otherwise unable to act. The Power of Attorney document can either be currently effective or it can “spring” into place if the client is ever diagnosed (by his or her doctors) as incapacitated. In either case, the client must be very careful not to name someone as Attorney-in-Fact that might abuse their power. For real estate investors, it is particularly important that bills are paid and properties are managed appropriately, regardless of the mental state of the property’s owner.Special estate planning considerations are also necessary for clients who invest into real estate using “self-directed IRA” (or IRA-owned LLC) structures.

About the author…
Warren L. Baker, J.D., LL.M. (Taxation) is a tax attorney with Amicus Law Group, PC in downtown Seattle and his areas of practice include estate planning, self-directed IRA tax consulting, and business transactions. Warren can be contacted at: 206-624-9410 or [email protected]

DISCLAIMER: THE FOREGOING IS NOT INTENDED TO BE GIVEN AS LEGAL, FINANCIALOR TAX ADVICE, BUT INTENDED AS GENERAL INFORMATION ONLY. IF YOU REQUIRE LEGAL, FINANCIAL, OR TAX ADVICE YOU SHOULD SEEK THE ASSISTANCE OF A QUALIFIED PROFESSIONAL.

“REAPS is the oldest – and largest – Professional Association for the real estate investor this side of the Mississippi. We provide education and networking resources for real estate investors, those who want to be investors and anyone who provides value to our members. Our goals are to motivate and support our members and guests through education, discussion, legislative action and networking. We host over 40 live events a year around Puget Sound and they are all open to the public. If you’ve never attended one of our meetings, just email our office at [email protected] and be our guest for free!”

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Feb
20

Lease Option Default

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When Your Lease Option Buyer Defaults On The Rent, What Can You Do

Some published authors on real estate investing recommend lease option arrangements as a good way for investors to market their residential properties to buyers who are temporarily unable to qualify for a conventional loan, but whom otherwise are satisfactory purchasers.  And such arrangements can be fine exit strategies for investors.  Under such an approach the investor collects at least enough in the option payment from the buyer to cover the real estate excise tax (yes, an option to purchase a property is a “sale” for purposes of the REET) and sets up the lease payments to at least cover the investor’s mortgage payments during the period of the lease.  The investor expects that when the buyer has repaired his or her credit by making lease payments during the option period, the investor will be cashed out by a conventional loan after the option is exercised.

Since the investor in this situation is both a landlord and a seller, the investor will naturally screen the buyers to make as certain as possible that they will be good tenants and have a reasonable chance to qualify for a loan at the end of the option period.  But what happens if, after all the investor’s due diligence, the tenant-buyer unexpectedly defaults on the rent?  Can the investor declare the option terminated, retain the option payment, evict the tenant-buyer and go on to market the property again?  A recent court case says it all depends on how the paperwork is written up.

In this case, the tenant-buyer of a commercial property under a lease with option to buy had a dispute with the landlord-seller over repairs and refused to pay rent until the repairs were made.  The landlord started an eviction case and won a decision from the court evicting the tenant-buyer.  The tenant-buyer then sent the seller a written notice of exercise of the option to buy, including the option payment as earnest money.  The seller refused to accept the notice and began a lawsuit to declare the option to buy to have been terminated.  The tenant-buyer argued that the lease and the option were separate documents and that there was no provision in the option that required the tenant-buyer to be in compliance with the lease in order to be eligible to exercise the option to buy.  The landlord-seller claimed that the lease and option were so intertwined that a breach of the lease terminated the option.  The trial court agreed with the landlord but the Court of Appeals reversed, saying that there were inconsistencies between the lease and the option that indicated that the parties intended them to operate separately.  The Court of Appeals said that the tenant-buyer still had the right to buy the property at the option price, even though it was in default under the lease and had been evicted.

It is common in the residential setting to write leases and options with an eye toward defending against arguments that tenant-buyers sometimes make in eviction cases that the lease and option are part of the same transaction which is in the nature of an equitable mortgage.   Such concerns mean emphasizing the separateness of the documents.  This case shows that there are also risks to which a landlord-seller is exposed when the lease and option are considered separate documents.  Proper wording of the paperwork can help to protect against such risks in both situations.

The foregoing is for instruction only and is not to be considered as legal advice.
About the author…
Doug Owens practices real estate law and general business law from his office in Seattle.   He offers a 10% discount for REAPS members and he can be reached at (206)985-6679 or [email protected]

“REAPS is the oldest – and largest – Professional Association for the real estate investor this side of the Mississippi. We provide education and networking resources for real estate investors, those who want to be investors and anyone who provides value to our members. Our goals are to motivate and support our members and guests through education, discussion, legislative action and networking. We host over 40 live events a year around Puget Sound and they are all open to the public. If you’ve never attended one of our meetings, just email our office at [email protected] and be our guest for free!”

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