Calculating ROI when estate and tax planning

Money you save is as important – perhaps even more important – than money you earn. The most obvious reason is that money earned is subject to income tax, while money saved is money preserved, dollar for dollar plus the rate of return on the retained, invested money.

Proactive planning

California’s relatively new Proposition 19 destroyed the legacy of Proposition 13, which kept property taxes low for millions of homeowners and their families. Now, massive property tax increases will be imposed on your children, those who will inherit your residence and other real property.

Following is a typical situation that we have seen countless times over the past few months.

Mr. and Mrs. P bought their home in the late 1970s for approximately $60,000. Their property taxes are now $3,000 per year. Their relatively modest home is in a nice area. Its value is now approximately $3.4 million. They want their daughter, a nurse living and working in the state of Washington, to inherit and retain ownership of the family home. She wants the option of making it her residence, though it is more likely that she would retain the home as a rental after Mr. and Mrs. P pass away and until she retires. Mr. and Mrs. P have modest invested assets and live on Social Security and a small pension. Their daughter also has limited income and is a single mother with two children.

Upon their passing, there would be a complete reassessment, and property taxes would increase to approximately $36,000 per year. This is an approximately $33,000 tax increase annually. If nothing is done, their daughter will be forced to sell the house because she cannot afford the property taxes.

Now assume that Mr. and Mrs. P, who are devoted to their daughter, take steps to preserve their very low level of property taxes for her benefit. Assume that legal and other fees to achieve this goal are $20,000. What is the ROI on this investment in tax-avoidance planning?

Over the first 10 years alone that their daughter inherits the house, at least $300,000 in extra property taxes would be avoided. Do the math: This is an astonishing 15,000% return.

In fact, the ROI is dramatically better because their daughter would have to earn as much as $500,000 over that 10-year period to have $300,000 available to pay the property tax after her income tax is paid.

Rethink your planning approach

We are all eager to increase the return on our investments from 4% to 5%, or from 6% to 6.8%. This is easy to calculate and easily understood. I suggest that a calculation of ROI by saving money is less obvious. Thus the blind spot.

The same point is made, of course, with regard to proactive, sophisticated income tax planning. The same point is made with regard to estate tax avoidance, an area where the ROI can be even more dramatic.

The process of capturing current property tax levels for the next generation is not simple. It involves the use of at least one Limited Liability Company, multiple transfers of property interests and a rather complicated irrevocable trust.

When property tax increases, in particular, are inevitably facing your family, don’t put your head in the sand. Realize that your children and grandchildren will face explosive property tax increases, increases that are avoidable with appropriate planning. Realize that appropriate, proactive planning is the key to success.

Michael Gilfix, Esq., is a partner at Gilfix & La Poll Associates in Palo Alto. For more information, call (650) 493-8070 or visit Gilfix.com.