I recently wrote a column for Top Producer Magazine regarding Dynasty Trusts. A reader responded to the column with a letter to Top Producer raising some very valid points and I would like to add my feedback to his letter.
His first couple of points deal with the lack of available land for others to purchase if the land is locked up in a Dynasty Trust with possibly hundreds of future beneficiaries being prevented from selling the land for its then highest and best use.
As I discussed in my column, this is a major drawback to the Dynasty Trust. Setting up a trust today with possibly 5-10 beneficiaries may sound like a great idea. However, what happens 200 years down the road when there are over 500 or even 1,000 beneficiaries trying to divvy up the income generated by 1,000 or 2,000 acres of good productive farmland. The accounting and trustee costs would likely eat up any profit generated by the Trust.
However, the reader must understand that farmers have the ability to tie up farmland for multiple generations already in the form of conservation or other easements. By placing an easement on the property, future generations are prevented from maximizing their value from the property. Dynasty Trusts are not the only tool to “lock-up” real estate for multiple generations.
Another point he raises is the lack of step-up in basis by having land pass through an estate. This is a valid point IF the land does not have an estate tax associated with it. For example, assume the estate has a value of the lifetime exemption amount. That land is then subject to an estate tax of 40% (federal) plus up to about 20% for certain states. The current maximum federal capital gains tax is about 24% plus an average state income tax rate of 8% equals a combined approximate 30% tax rate (after reflecting that state income taxes are deductible on the federal tax return). Which would you rather pay – 40% or more or 30%.
This is a question that we as advisors struggle with on larger taxable estates. If there is no estate tax due, then we want the asset to run through the estate. If there is estate tax due, then we would rather get it out the estate and pay the capital gains tax later. And for most farm families, the intent is not to sell the farmland, so the step-up only helps if they actually sell.
It is tough to cover all aspects of Dynasty Trusts in a 900 word column, however, my intent of the column was not to promote a Dynasty Trust, but rather spell out the possible advantages and disadvantages. They are not for every farm family.