Curb Your Enthusiasm comedian and veteran stand-up act Richard Lewis, who recently passed away, didn’t just have a sharp wit; he had some sharp financial moves regarding real estate, too. According to the New York Post, he made some proactive moves six months before he passed to ensure his wife, Joyce Lapinsky, could continue to live in their Los Angeles home after he died. He accomplished this by switching his standard mortgage to an assignment of rents trust deed.
So, what is an assignment of rents trust deed? According to rent.com:
“The assignment of rents is a legal mechanism whereby a property owner (often a borrower) assigns the right to collect rent payments from a particular property to a third party, typically a lender. This is usually done as a form of security interest for a loan or mortgage. The primary purpose of the assignment of rents is to provide financial protection to the lender if the borrower defaults on their loan.”
A Lender Is Protected Without the Need to Foreclose
The benefit to the lender is that they are assured of receiving monthly payments in the form of rent, which is applied to debt owned by the borrower when they are not making payments. While the assignment of rents clause is often used in commercial loans, it’s less often applied to residential homes, which usually have a regular mortgage.
In the case of borrower default, the assignment of a rent trust deed kicks in as an alternative to foreclosure, bringing the borrower out of default. Once the borrower is out of default, the lender must stop collecting rents. It works like a sump pump—it’s an emergency fail-safe, pumping a borrower out of default by using rental cash.
The Homeowner Needs to Find A Place to Live If The Assignment of Rents Clause Is Activated on a Personal Residence
So, how does this help Richard Lewis’ widow? In the case of Lewis’ house, a three-bedroom, three-bathroom home purchased in 2016 for $1.53 million, should his wife default, the home can be used as a rental as a stopgap measure to allow her to keep it in her name. Where she—or anyone using this strategy on a personal residence—-will live while their residence is being rented remains an issue they must resolve.
For real estate investors who plan to pass on rental units to their heirs, this maneuver safeguards the asset from a possible foreclosure. However, issues can arise when the rent does not cover the loan due or when landlords contest the lender’s right to keep the rent.
Strategies to Protect Your Real Estate Assets After Your Death
If you’re a real estate investor, sitting down with an estate planning strategist is one of the smartest things you can do long before you reach your senior years. If you own properties worth more than $12.92 million for individuals and $25.84 million for married couples, you could face up to 40% tax rates for 2023.
Here are some strategies to consider.
Put your assets in a corporate entity
Most asset protection specialists will advise putting an investment property in a corporate entity, with a limited liability company (LLC) being the most common. Your LLC will then also need to be protected.
You can accomplish this by getting LLC insurance. Ensure your LLC is maintained as a separate entity and that funds are not co-mingled (don’t use your LLC to pay personal bills without first transferring the money out of the LLC account).
Take extra measures to shield your LLC from another entity. Talk to an asset protection specialist about nuanced ways to accomplish this.
Get a will
A will is the most often used way to indicate what you wish to do with your assets after death. However, it won’t elevate the tax burden on your beneficiaries.
Establish a trust
Trusts are one of the best ways to minimize taxes. According to The Motley Fool, wealthy real estate owners often use various trusts, including grantor-retained trusts, dynasty trusts, and generation-skipping trusts, to minimize the tax burden on their heirs.
Here’s a look at each kind of trust:
- Grantor-retained annuity trusts (GRAT): These allow property owners to transfer appreciating real estate to heirs without incurring gifts or estate tax while the owners are still living. The grantor transfers assets for a specified period while receiving income as an annuity. The asset appreciation in the trust passes on to the beneficiaries free of gift and estate tax, while the owner gets back the principal.
- Dynasty trust: As the name suggests, a dynasty trust allows a property owner to transfer wealth to multiple generations free of transfer taxes, such as estate and gift taxes. This means that assets transferred into a trust, along with an increase in value, are only subject to federal gift/estate tax once. From then on, they’re safe from estate taxes and can benefit multiple generations. This is great for owners of large real estate portfolios that increase annually in value.
- Generation-skipping trusts: Love your grandkids but don’t get along with your kids? A generational trust allows grantors to pass on property to their grandchildren or other beneficiaries who are two or more generations younger than them. There’s a more practical reason for this trust, however: It allows you to avoid the estate taxes that would be incurred if you passed on the property to your children first.
A 1031 Exchange and Step-Up Basis
In addition, family LLCs that leverage 1031 exchanges are another way to limit tax exposure.
Most savvy investors are probably familiar with the 1031 exchange as a vehicle for deferring capital gains taxes when you sell one investment property and buy another. The step-up basis component of a 1031 exchange allows the beneficiaries to receive property at its current market value rather than the original purchase price, meaning they do not have to pay capital gains taxes on the asset’s appreciation during the deceased’s lifetime. Beneficiaries can sell the property once the step-up basis is realized without incurring capital gains taxes.
Final Thoughts
Whether you own one personal residence like Richard Lewis or have thousands of units in your portfolio, protecting your assets and creating a plan to pass them on to your heirs or sell them without incurring high capital gains or inheritance taxes is prudent. Fortunately, there are a variety of strategies to choose from, and modifying your approach as your portfolio accrues is a common approach. Discussing a game plan with an expert should be your first step.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
