Dear Clients, Colleagues, and Friends,
California… A land of golden sandy beaches, ancient towering trees, world-changing innovation, perfect sunny weather… and taxes.
Lots and lots of taxes.
One thing Californians could always count on, until recently, was that their state and local taxes (S.A.L.T.) could be deducted from their annual federal tax returns, easing what was already a hefty annual tax burden. This included an annual deduction for property taxes. However, the GOP’s new Tax Cuts and Jobs Act, which went into effect earlier this year, now caps taxpayers’ federal deductions from S.A.L.T. at a meager $10,000.
In a state with an average federal tax deduction around $22,000, skyrocketing home values, combined with an annual average property tax rate of 1.25%, means that federal taxes are suddenly going to get a lot more expensive, as will home ownership.
This is true for all high tax states and those in New York, New Jersey and Connecticut are projected to also be heavily affected with much higher federal tax bills this year. While state legislatures struggle to find solutions for their homeowner constituents, tax professionals are working within the existing system to ease the burden.
Luckily, there is a novel solution for high net worth individuals who have property taxes exceeding $10,000.
The use of an IRS approved trust allows home owners to benefit indirectly, that which they now cannot directly, utilizing the property tax deduction of up to $10,000 for state and local taxes – for each trust. That means if the real property taxes on a home are $40,000 per year, four trusts could be set up to allow for the deduction of the entire $40,000 instead of the cap of $10,000 on state and local taxes (S.A.L.T.).
Sound too good to be true? It’s not – but the solution is complicated and requires the expertise of qualified professionals.
First, a homeowner must set up an LLC in a no-tax state such as Nevada or Alaska. Then, fractions of that LLC are transferred into multiple non-grantor trusts. Unlike a grantor trust, where the person who creates it is generally taxed on the trust income, non-grantor trusts are treated as separate taxpayers, and each trust can take a deduction of up to $10,000 for state and local taxes, offsetting its taxable income, for huge savings.
Because the trust creator can no longer control or benefit from anything placed in the trust, this solution works best if the trust owns income producing assets which generate enough income to balance out the $10,000 deduction. For example, marketable securities or an income-generating real estate investment are two viable options that will generate income inside the trust.
There are some limitations to the benefit of non-grantor trusts. For example, if the home in the non-grantor trust is sold, the trust recognizes the gains on the sale and it must pay taxes on it. It also might not be able to take advantage of special home sale exclusions available under separate tax rules. And in some states, transferring the home to an LLC may trigger an additional tax.
Because of the complexity and nuances of this solution, it’s important to consult with a well-qualified tax and estate planning attorney who can walk you through its details and how this solution might apply to your specific situation. While building and administering the trusts involves up-front fees, such expenses pay for themselves after a few years.
Benjamin Franklin once famously said, “In this world nothing can be said to be certain, except death and taxes.” In this case, while taxes are still certain, they can be at least a little less burdensome.
Call our offices for a consultation to learn more about how your assets – and your bottom line – might benefit from a non-grantor trust.