Authored by Vimala Snow and Dan Terlep
Estate planning is Critical in Order for Wealthy Families to Preserve Their Legacies
Advanced estate planning is an important issue for families of means to properly address. One of the most common ways to transfer an asset to children or grandchildren is by making outright gifts. This entails using the lifetime gift tax exemption (the “Exemption Amount”) to shield the gift from gift tax (maximum rate is currently 40%). Today, the Exemption Amount is roughly $11 million for an individual or $22 million for a married couple. Although the Exemption Amount is significant, many wealthy families find that their desire to create a legacy for their family is limited by it. Fortunately, there are several estate planning methods that can be used to efficiently transfer a legacy to future generations.
Investing in a QOZ Presents a Planning Opportunity
An increasingly popular way to reduce taxes generally is to invest in Qualified Opportunity Zones (QOZs), but the use of QOZs to shift the appreciation of wealth over time to future generations is less well known. Investors have various options for transferring interests in QOZs to future generations in a tax-efficient way. Several items should be evaluated:
- What will be the value of the QOZ over time?
- Why would you transfer the QOZ interest?
- What are things to be aware of when making this decision?
Assets that appreciate significantly and that have a discount associated with their current market value can be ideal for moving wealth to the next generation. A QOZ investment enhances the ability to transfer wealth as it is both long-term in nature due to its investment time-line and because the inherent deferred tax liability will further reduce the transfer tax value of the asset, allowing the grantor to transfer more assets than would have otherwise been possible.
What is a QOZ?
Tax legislation in 2017 created the opportunity to invest in a QOZ and receive numerous benefits for doing so. In essence, a taxpayer can receive tax benefits for timely investment of capital gains in property or businesses located in certified communities through a QOZ fund. Investments in QOZs are eligible for three core benefits:
- Deferral of capital gains tax from the sale of any asset with a maximum deferral through 2026. 
- Reduction of tax of up to 15% of the deferred capital gains for investments held for 7 years. 
- Complete avoidance of tax on the investment’s appreciation if held for at least 10 years. 
How to Combine Investing in a QOZ with Estate Planning
An effective and widely accepted way to magnify the impact of a gift is to transfer assets to a “grantor trust” – that is, a trust that takes advantage of the mismatch in the income and estate tax rules. More specifically, a trust can be created which insulates its assets from estate tax while at the same time being ignored for income tax purposes. This not only allows the wealth creator to continue to pay tax on any income generated within the trust, but also facilitates additional planning opportunities as transfers between the grantor and the grantor trust are ignored for income tax purposes.
As noted previously, an appreciating asset that is subject to discounts for lack of marketability and/or lack of control only serves to enhance the impact of a transfer to a grantor trust. A QOZ interest would not only receive a lack of marketability discount due to its long-term nature, but would also benefit from a reduction due to the deferred capital gain when arriving at a value for transfer tax purposes. The combination of these two factors, in addition to the lack of control, may provide a significant discount on the value. A discount range of up to 50% would not be unreasonable for this type of asset. Because of the $11 million limit on tax-free gifts, the significant reduction of value can create a way to move future appreciation to heirs at lower transfer costs today. In evaluating the transfer options, an investor should be aware that the Income in Respect of a Decedent rules apply to QOZs.
Several scenarios are worth comparing. The first comparison below demonstrates the results of (1) a transfer of a typical investment to a grantor dynasty trust against (2) a transfer of an interest in a QOZ to a grantor dynasty trust. The second comparison shows the outcomes of (1) holding an investment in a QOZ for heirs until death against (2) a transfer of the interest in a QOZ to a grantor dynasty trust. In each comparison, the transfer to a grantor dynasty trust produces a net advantage to the heirs, $6.8 million and $7.7 million, respectively.
The analysis is for illustrative purpose and not a guarantee of performance or the strategy or types of investments that may apply to you.
There are several current income tax benefits to be gained from investing in QOZs; given the long-term nature of their investment timeline, they are also worthy of consideration as vehicles for transferring the appreciation of wealth over time to future generations.
 IRC §§ 2501-2502, 2001(c).
 Rev. Proc. 2018-57.
 IRC § 1400Z-2(a)-(b).
 IRC § 1400Z-2(b)(2)(B).
 IRC § 1400Z-2(c).
 IRC § 2010; Rev. Proc. 2018-57.
 The non-QOZ investment transfer to trust model assumes the following: (a) initial value of assets being sold to a dynasty grantor trust equal to $7.62M ($10M less capital gains tax of $2.38M), (b) a 30% discount rate for lack of marketability and control, (c) an applicable long-term AFR note to facilitate the sale, and (d) $533k seed gift to the trust (reflecting 10% of the discounted asset).
 The QOZ investment transfer to trust model assumes the following: (a) initial value of assets being sold to a dynasty grantor trust equal to $10M (due to deferral of associated capital gain through 2026), (b) a conservative 50% discount rate for lack of marketability and control and deferred income tax liability, (c) an applicable long-term AFR note to facilitate the sale, and (d) $500k seed gift to the trust (reflecting 10% of the discounted asset).
 All of the examples share the following features: (a) 10% rate of return for the primary investment and a $3M cash investment earning 3% held individually to be utilized for payment of tax obligations, (b) grantor lives through 2026 and pays tax on deferred capital gain of $8.5M with other assets, (c) a comparison of the estate tax savings benefits and income tax savings, (d) lifetime exemption amount is equal to $5.2 million in year 10 and only exemption used was an initial gift funding for two trust scenarios, and (e) no state income tax obligations (all gains are long term capital gains at 23.8%).