Estate Planning

Aug. 1, 1997
Many years ago, I set up a retirement plan through my corporation and have now accumulated $1,500,000 at age 55. I recently talked with my accountant regarding my estate planning.

Charles Blair, DDS and

John McGill, MBA, CPA, JD

Question:

Many years ago, I set up a retirement plan through my corporation and have now accumulated $1,500,000 at age 55. I recently talked with my accountant regarding my estate planning.

He recommended that I review my retirement-plan beneficiary form. In reviewing this, I noticed that I had listed my estate as the beneficiary, rather than my wife, to have the maximum flexibility for estate-planning purposes. Is this still the best approach?

Answer:

No. Naming your estate as beneficiary of your retirement plan or IRA accounts can have disastrous tax consequences. Under current law, such a designation requires that all proceeds of the account be paid out within five years of the date of death. With a large retirement or IRA balance such as yours, this will require large annual payments over the five years, subjecting most of the distribution to federal and state income taxes at the highest marginal rates. In addition, this short-term payout will subject a portion of these funds to the 15 percent excise tax.

Finally, the retirement-plan balance will be subject to federal and state death taxes at your death. The combination of these taxes easily could take 75 to 80 percent of your total retirement-plan balance.

Naming your surviving spouse as beneficiary is the approach that we would recommend. Under this approach, your estate would receive a deduction for the entire balance of your retirement-plan balance, which is transferred to your surviving spouse at the date of death. In addition, your surviving spouse would be able to withdraw these funds over her remaining life expectancy, stretching out the distributions and, thereby, lowering the federal and state income taxes otherwise applicable. This would substantially reduce or eliminate any applicable 15 percent excise tax on these funds.

Question:

I am in the process of selling my practice and have struck a deal with a potential buyer. In connection with the sale, I plan to lease the office building to the buyer for a period of five years, rather than selling it. However, the buyer is now adamant that he wants to purchase the building at the same time as the practice, and I feel that I need to accommodate him to avoid the entire deal falling through.

I discussed this with my accountant and got some shocking news. I purchased my office building many years ago for $250,000 and now it is fully depreciated except for $25,000 in cost basis remaining in the land.

During the period of ownership, the building has increased in value to $425,000, so that I am looking at a net gain of $400,000 if I sell the property. This would result in federal and state income taxes of over $130,000 on the capital gain. What can I do?

Answer:

The first option to consider is to structure the transaction as an installment sale. With an installment sale, you may be able to spread the gain out over many years, which will reduce the amount of taxable income you report each year. If you have little other income to report, some, or all, of this gain may be taxed at the lowest marginal federal income-tax rate of 15 percent, rather than the maximum rate of 28 percent, which otherwise applies to long-term capital gains.

If you are looking to reinvest in other real estate, a tax-free exchange may serve your purposes better. Under Section 1031 of the Internal Revenue Code, a doctor realizes no gain or loss when he exchanges real property used in a trade or business or held for investment purposes for other like-kind property. While the rules are fairly complex, generally the doctor must swap properties at the time of the sale or structure a deferred exchange that meets the requirements of Section 1031.

In a deferred exchange, the doctor can sell the office building and have all funds held by a qualified intermediary acting as an escrow agent. Thereafter, the doctor has 45 days to identify the property (replacement property) he would like the escrow agent to purchase on his behalf and 180 days to actually take title to that property.

Provided these requirements can be met, you can avoid all federal and, in most cases, state income taxes on the transaction.

For more information regarding tax-saving strategies involving the potential sale of an office building, send a self-addressed, stamped (52 cents) envelope to the address below and request, "More Creative Tax Strategies for the Sale of Your Practice and Building."

Dr. Blair (left) is a nationally known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. The newsletter ($149 a year) and consulting information are available from Blair/McGill and Company, 4601 Charlotte Park Drive, Suite 230, Charlotte, NC 28217; or call (704) 523-5882.

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