Effective estate planning is essential for everyone, particularly those with substantial assets and complex financial structures like those in the commercial real estate sector. A well-strategized estate plan safeguards your legacy and protects your loved ones if you become incapacitated or pass away.
While 56% of U.S. adults recognize the importance of estate planning, only about 32% have done so. In fact, according to a survey conducted by Caring:
- 41% of people between 18 and 34 and 34% between 35 and 54 haven’t discussed estate planning with anyone.
- 60% of people lacking a will haven’t made a living trust or created any other estate planning document.
- 40% think they don’t have enough assets to justify having a will
And yet, according to SeniorLiving, American retirees expect to transfer more than $36 trillion to their families, friends, nonprofits, and additional beneficiaries in the next 30 years.
So why the delay? In many cases, it’s because people fear confronting their own mortality and, let’s face it, having this conversation — whether you’re the older or younger person — is never easy. But, estate plans allow you to ensure that your assets are handled according to your wishes. And if you’re involved in commercial real estate, the planning is a bit more complex.
Why estate planning is different for commercial real estate
CRE does create a few additional complications in estate planning, so it’s better to plan sooner than later — and revisit those plans as situations evolve. Estate planning for CRE investors is more complex than for those with only residential or personal assets, requiring strategies to manage the unique challenges of commercial property ownership and succession.
- Ownership complexity: Commercial real estate is often held through multiple entities like LLCs or partnerships to help manage financial investments and tax structures, which can complicate ownership and transfer.
- Business continuity: Estate planning must ensure the business continues smoothly after an owner’s death, including managing tenants, debt, and operations.
- Succession planning: Real estate investors may have multiple properties, each with varying debt, value, and potential for appreciation, requiring careful planning for how to manage and distribute those assets.
- Debt and liabilities: Commercial properties often include significant debt obligations, which must be factored into the estate plan.
- Asset protection: Estate planning helps protect business assets from potential risks and liabilities, ensuring continuity even should something happen to the owner.
- Tax implications: CRE involves intricate tax considerations, including federal estate, gift, income taxes — and transfer taxes from state to state.
Estate planning tips for CRE investors
- Create a living trust: A living trust enables property transfer while maintaining lifetime control. It bypasses probate and allows you to distribute assets to your beneficiaries while still living (and avoid probate). It does not, however, offer liability protection.
- Establish a family limited partnership (FLP): By creating an FLP, you can transfer property to your family while retaining management, offering tax advantages and a structured ownership takeover.
- Use a qualified personal residence trust (QPRT): A QPRT enables the transfer of a residence or vacation home to your heirs with reduced gift tax liability — it’s especially advantageous for appreciating properties and allows the grantor continued occupancy for a set time.
- Plan for capital gains and estate taxes: Since real estate values typically increase, consider a stepped-up basis to lessen the capital gains tax burden for your heirs. This method revalues the property at the time of inheritance, minimizing their tax obligation.
- Think about gifting real estate to your heirs: Lifetime real estate gifts can decrease your taxable estate. By using the annual gift tax exclusion, you can transfer property without gift tax, effectively reducing your estate’s size.
- Include strategies for liability protection: For real estate investors, prioritize liability protection. Using LLCs or similar entities shields your personal assets from legal claims and creditors and enhances investment security. Combining an LLC with a trust provides another layer of protection since corporations are typically not used in real estate estate planning.
- Designate one or more successors for property management: If you own rental properties, designate a manager (family member, professional, or trustee with appropriate real estate expertise) in your estate planning.
Understanding capital gains and depreciation recapture
To prepare for selling commercial real estate planning, you must understand the potential tax implications, including capital gains and depreciation recapture, and consider strategies like 1031 exchanges or qualified opportunity zones to minimize tax liabilities.
Capital gains apply when an asset (like property) is sold for profit. Unlike ordinary income, these gains are taxed at specific capital gains rates. The length of ownership and method of divestiture influence the applicable tax rate. During estate planning, CRE investors and their financial planners should be well-versed in these tax considerations.
The difference between transfer taxes in NJ vs. NY
New Jersey imposes a transfer tax when you record a deed: a realty transfer fee (RTF) and a mansion tax (applied when a property sells for $1 million or more). New York charges the same two real estate transfer taxes as well, although the percentages for the regular transfer fee differ based on whether the property is located in a city with a population of one million or more (NYC). Here’s a breakdown:
NJ transfer taxes
Typically, the seller covers the RTF, but buyers and sellers can agree to a different arrangement, provided the fee is paid when the property deed is officially recorded. It’s important to note that even if the buyer pays, the seller remains ultimately responsible for any unpaid or additional fees discovered after the recording.
The RTF is calculated on the total value exchanged in the property transfer, including the purchase price, existing mortgages, liens, or other financial obligations assumed during the transaction. Higher transfer fee rates apply to transactions exceeding $350K. For leases lasting 99 years or longer, the calculation is based on the property’s assessed value at the lease’s inception. A property sale exceeding $1 million triggers the mansion tax, a levy of 1% calculated on the total consideration documented in the deed and payable by the purchaser at recording.
The state’s Controlling Interest Transfer Tax (CIT), N.J.S.A. 54:15C-1, requires buyers to pay a 1% fee on controlling interest transfers in entities owning commercial real estate (Class 4A) valued over $1 million. This tax is waived if the buyer pays the standard transfer fee on the property.
NY transfer taxes
New York State imposes transfer taxes, but the transfer taxes for NYC are a significant revenue generator that’s anticipated to bring in $1.225 billion in FY 2025. These taxes, paid to the government by the seller, are due for every type of property — residential and commercial — and for ownership transfers in an organization that owns property. A caveat: buyers are responsible for paying the mansion tax and supplemental tax (if any).
Residential Type 1 and Residential Type 2 properties below $3 million pay a 0.4% NYS transfer tax and a 0.65% NYS transfer tax if valued at or over $3 million. In NYC, the transfer tax is 1% for properties under $500K and 1.425% for properties valued at or more than $500K.
Commercial properties like offices, retail, rental buildings, warehouses, etc., pay higher transfer taxes. The state charges 0.4% for buildings sold under $2 million and 0.65% over $2 million. NYC’s transfer tax is 1.425% for properties sold for under $500K and 2.625% for properties with a sale price over $500K.
Only a few property types are exempt from these transfer taxes:
- To or from non-profit organizations
- Used to secure debt
- From an agent to its principal or vice versa
- Where beneficial ownership remains the same
- By an executor, as outlined within a will, transfer taxes still apply if the executor sells the property.
If you’re among the greater percentage of Americans who don’t have a will or who haven’t thought about estate planning, it’s time to call your financial planner to understand your overall financial picture — and then make an appointment with an attorney who specializes in estate planning.
The members of CREA United can help. We invite you to talk to the professionals at CREA United, an organization of CRE professionals from over 90 firms representing all disciplines within the CRE industry, including attorneys, portfolio managers, financial planners, and other professionals well-versed in the complexity of commercial real estate.
