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Almost all of us have been impacted in one way or another by the current recession. Even prosperous and successful investors and business owners have seen the value of their investments and business interests dwindle in the face of the “Great Recession.” Although it appears the dark clouds of economic strife have slowly begun to clear on the horizon, the current economy still presents a silver lining opportunity for those individuals and businesses contemplating a transfer of family business holdings, real estate or other investments to the next generation.
IRS mandated Applicable Federal Rates at an All-time Low
The IRS prescribes Applicable Federal Rates (AFR) every month. These rates essentially represent the minimum allowable interest rate that will be respected by the IRS in a loan transaction. Loans with no prescribed interest or interest rates below the AFR trigger the application of imputed interest rules which can have both income and estate tax consequences. For the month of December the applicable rates are as follows: the short- term rate for loans with a maturity of less than three years is .32%, the mid-term rate for loans with a maturity of greater than 3 years but less than 10 years is 1.53%, and the long-term rate for loans with a maturity greater than 9 years is 3.53%.
With the AFR this low, there is an obviously favorable potential to make highly affordable loans from a wealthy parent or grandparent to an heir or beneficiary. Used in conjunction with a purchase of an income producing business interest, real estate asset, or other investment this type of loan is a simple but highly effective method to facilitate the transfer of wealth between generations.
The AFR also affects certain IRS valuation tables used to determine the value of annuities, life estates, term interests or remainders for estate, gift and income tax purposes. As interest rates decline, the value of life estates or income interests in property increases proportionately. Likewise, lower interest rates result in lower annual payments for annuities. The valuation benefits of the current historically low interest rates create an opportunity to use certain estate planning techniques such as the Grantor Retained Annuity Trust (GRAT) or private annuities between family members to leverage the transfer of assets between generations.
The Valuation “Perfect Storm”
The recession has affected more than just interest rates. Hard economic times and stricter bank lending standards have pushed down the value of real estate and closely held business interests significantly. The hard realities of trying to sell a property or a small business in this economy should be reflected in an appropriate valuation discount applied to determine the true fair market value of assets for estate or gift tax purposes.
The cost of a current transfer will likely be returned as future appreciation inures to the benefit of designated beneficiaries. As the economy recovers, the value of most properties will rebound. Likewise, many closely-held businesses made lean and efficient through the demands of the harsh business environment will be able to grow as things return to normalcy.
The lack of action by Congress has cast uncertainty on the estate planning landscape. At this time, we are still unsure if we will return to the costly Pre-Bush era estate and gift tax system or if there will be some compromise reached to put in place a more equitable and affordable structure of estate tax rates and exclusions. Yet in the face of this confusion the fact that the current low interest rates and depressed asset values represent a historical opportunity to efficiently transfer assets is fairly incontrovertible. The tax and family business experts at Bond Beebe can help you to evaluate your business and personal needs to determine if you should consider taking advantage of this opportunity.
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