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Don’t Shed Tiers

By Tim Berry, JD - Email Editor

Date : November 19, 2009

Have you guys ever seen the last episode of Lord of the Rings? I can never walk past a TV playing the scenes where those gigantic rocks are flying around, either smashing some bad guys head in or crashing against the castle walls. I’m pretty much hypnotized. As for the castle walls how many sets of them were there, 4 or 5?

After all, do you really want your queen there to greet the mad hobgoblins when they crash down the first wall? Probably not.

So let’s apply the concept of multiple walls to asset protection. A large staple of asset protection is selling your assets to a trust you establish for your spouse and kids. Typically the sale isn’t for cash; rather it is a promissory note the trust gives to you the “grantor” of the trust.

For example, if I had $10 million in cash lying around, and I wanted to get the future appreciation of that cash out of my estate, I would loan the $10 million to my family trust at the current interest rate, let’s say 4.5%. The estate planning benefit would be that any growth in the $10 mil over and above 4.5% annually would not be subject to estate taxes if I did things right.

Let’s go a bit further with this example. What if I got in a lawsuit, lost, and my judgment creditor were able to take away the promissory note? Would that be a complete disaster? Well, that really depends upon how the promissory note was drafted. If it called for monthly payments of interest and principal, then sure, you are going to be drinking heavy that night.

However, what if the promissory note merely called for a lump sum balloon payment 5 years down the road? 10 years down the road? 30 years down the road? Now I hear some of you yelling “foul” in the background, saying everything has to be commercially reasonable. Have you ever heard of Treasury Strips? Probably tens, if not hundreds, of billions are in circulation.

But what would a castle analogy be without boiling oil thrown over the ramparts? A particularly nasty feature of these “stripped” promissory notes is that if a judgment creditor does take them away, the judgment creditor is going to be hit with “phantom” income each year. Ouch!

Along the same lines as the stripped promissory notes would be private annuities. A number of insurance companies issue annuities with the understanding that no payments will begin until the client turns 70.5. If the insurance companies can do it, so can your family trust. Now if you lose that lawsuit and the judgment creditor takes away your annuity contract, they don’t get squat until you turn 70.5. In the meantime your family trust has full use of the principal and is entitled to any earnings over and above the amount that is supposed to be paid back to you.

Oh yeah, the phantom income rule can apply for the annuity as well.

Another little used concept is splitting up ownership of real estate into undivided interests, commonly known as tenants in common interests (TIC). While there are a lot of commercial real estate projects that have been split into TICs, there are few residential properties divvied up like this. About the closest example would be time shares. We all know how much time share interests sky rocket in the secondary market (it’s a joke people).

All you need to do is sell a portion of the property to your family trust, and retain the rest as a TIC with the trust. Then in your TIC agreement you have both parties agree that upon certain occurrences each TIC has the right to purchase the other party out for fair market value.

Example: You have a $1,000,000 house. You sell a 5% TIC interest to your family trust for $50K. As part of the TIC agreement between you and your family trust, each party has the right to buy the other out for fair market value (FMV). What exactly is the FMV of a 95% interest of real estate? I don’t know, but I can pretty much guarantee it isn’t $950,000 or higher.

Let’s go into double bonus round with this example. Not only could the TIC agreement give each party the right to buy the other out for FMV, but it could also say the deal does not have to be cash. Instead, the payment could be via a “stripped” promissory note from above.

So don’t wait until you see the dust clouds from all the mean nasty guys approaching you. When you start building up the defenses for your assets, don’t just rely upon one layer of protection. That layer is probably going to fail one way or another. Make sure you have multiple tiers and walls so you can survive to fight another day.

Feel free to email us at info@trustmakers.com or call to discuss your options.

If you would like to discuss the use of trust for you, your family, or even as a marketing tool for your business, give us a call we would love to talk with you about it. Please contact us at info@trustmakers.com

By Tim Berry, JD
TrustMakers.com

 

 

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