Jonathan Blattmachr, an estate planning lawyer, is such a fan of the strategy he’s created to help some of his wealthy clients get around the new property tax deduction cap that he’s using it himself.
Blattmachr plans to put his two New York residences — in Garden City and Southampton on Long Island — into a limited liability company. Then he’ll transfer interests in the LLC to five separate trusts set up in Alaska, with each taking the maximum $10,000 deduction. By doing so, he says he’ll be able to preserve the write-off for about $50,000 in property taxes he and his wife pay each year on both homes.
“This is an under-the-radar thing and it’s novel,” said Blattmachr, who’s written several books on estate planning.
The provision most bitterly opposed during the legislative debate was the $10,000 limit on federal deductions for state and local taxes, or SALT. Since the law took effect, half a dozen wealth planners say they’ve seen a surge in interest in so-called non-grantor trusts among residents of high-tax states such as New York, New Jersey and Connecticut.
While trusts are generally used by the richest Americans, non-grantor trusts for property tax deductions make the most sense for the merely well-off who have property taxes totaling up to $100,000, tax experts say.
Setting up dozens of non-grantor trusts for those with six-figure plus property taxes can be impractical and burdensome. Plus, those whose taxes are under six figures feel the new cap most acutely, according to Steffi Hafen, a tax and estate planning lawyer at Snell & Wilmer in Orange County, California. Those clients often have monthly mortgage payments that eat up a big chunk of their take-home pay, Hafen said.
More than 10 percent of taxpayers in New Jersey will see a tax hike under the new law — the highest percentage in the U.S. — followed by Maryland and the District of Columbia at 9.4 percent, 8.6 percent in California and 8.3 percent in New York, according to an analysis earlier this year by the Tax Policy Center. Those who’ll pay more are mostly being affected by the state and local tax deduction limit.
Mark Germain, founder of Beacon Wealth Management in Hackensack, New Jersey, said the strategy is “absolutely viable,” adding that he has about a dozen clients who want to create non-grantor trusts.
Building and administering the trusts could cost about $20,000, according to Brad Dillon, a senior wealth planner at Brown Brothers Harriman. But those expenses would be justified after a few years, said Scott Testa, a lawyer who leads the estates and trusts tax practice at Friedman LLP in East Hanover, New Jersey.
Still, the Internal Revenue Service could issue guidance that would prevent taxpayers from using the trusts to get around the SALT cap. An existing provision says that multiple non-grantor trusts with identical beneficiaries and identical grantors — and whose primary purpose is to avoid taxes — can potentially be considered a single entity, with just one $10,000 SALT deduction. But the measure has never been bolstered by regulations, leaving it vague.
That IRS provision could potentially derail the whole strategy, Dillon said. But compared to the other workarounds that have been proposed by high-tax states, the non-grantor trust “is the only one that’s come out of the fray that seems like a viable structure,” Dillon said.
Mansion Tax
Here’s how it works: First, you set up an LLC in a no-tax state such as Alaska or Delaware. Then, you transfer fractions of that LLC into multiple non-grantor trusts, which are trusts that are treated as independent taxpayers (unlike grantor trusts, where the person who creates them are generally taxed on the trust income). Each trust can take a deduction up to $10,000 for state and local taxes.
If a spouse is designated as the beneficiary, another “adverse” party — meaning someone who may want the money also — has to approve any distributions.
Keep in mind that you no longer control or can benefit from anything placed in the trust. And you have to put investment assets in the trust that will generate enough income to balance out the $10,000 deduction. One option would be a vacation home that generates rental income, according to Steve Akers, chair of the estate planning committee at Bessemer Trust. Marketable securities could also work.
Some caveats: If the home placed in the non-grantor trust is sold, the trust recognizes the gains on the sale and has to pay taxes on it — and it won’t be able to take advantage of a special home sale exclusion that’s available under a separate tax rule. For those with New York residences, putting the home in the LLC or the trust could potentially trigger the state’s 1 percent mansion tax, which is levied on sales of homes of at least $1 million.
‘SALTy-SLAT’
Also, non-grantor trusts may not work for certain taxpayers. Borrowers with large mortgages may be blocked, since their banks may not approve the transfer of the home to an LLC.
Taxpayers whose primary residence is Florida can’t use the strategy either because of complex rules related to the state’s homestead exemption, said George Karibjanian, an estates lawyer in Florida and Washington.
Another estate planning lawyer, Martin Shenkman, said he’s setting up an LLC and two non-grantor trusts for his condo in New Jersey. Shenkman calls the strategy the SALTy-SLAT — a SLAT is a specific kind of trust.
“This new tax law has made planning more granular,” Shenkman said. “But for a fairly large number of taxpayers, this is doable.”
— With assistance from Laura Davison and Ben Steverman
