Planning Briefs

(Wednesday, Sept. 2, 2020; 11:00 AM EST) Whether you're a grantor or beneficiary of a taxable estate, current conditions require attention.  Stock market volatility and drops in real estate values in cities, two financial side-effects of the Covid pandemic, create considerable opportunities to transfer family holdings to the next generation.

The minimum interest rate on intrafamily loans, which is set by the IRS, was only 18 basis points – that's 18 one-hundredths of 1% --in June 2020. That would allow a grandparent to loan $1 million, $10-million, or more, to a child or grandchild for up to three years and the only money grandpa would be required to count as income is the loan interest of $180 annually. Meanwhile, the loan amount could be in stocks or real estate for three years and any appreciation would not be subject to estate tax.

This is a simplification of the tactic. In real life, it generally involves creating a trust to protect the assets loaned from the possibility of a legal claim, just in case a beneficiary gets divorced, targeted in a lawsuit by business creditors, or in the event someone slips and falls on your property.

With the presidential election and Covid, between now and the end of 2020, the stock market may be volatile. A one-day plunge of 7% occurred earlier in the Covid bear-market recovery. If a big drop like that occurs again between now and the end of 2020, the next big plunge could be an opportune time to consider a loan to children or grandchildren to effectively transfer wealth to the next generation, if you believe stocks will appreciate 1% or more.

Past performance is never a reliable indicator of what your future investment results will be, but it is important to be mindful that the historical annual rate of return on stocks is about 10%. Thus, assuming a return for the next three years of 1% annually – one tenth the historical norm –is a very conservative expected return and yet it would still make this tactic a profitable investment. And if the stock market returns anything like the historical norm, then your heirs are way ahead, because the gains would not be taxed with the rest of your taxable estate.

For families with real estate holdings in cities where values have declined sharply, the same logic holds true. If you think your real estate will appreciate more than the current applicable federal rate, this is an opportune moment to consider loaning assets within a trust.

The general information above cannot address your individual situation but is intended only to educate families about current tax and financial economic conditions. Legal, tax, or financial advice depends on your specific situation.