The Importance of Value Appreciation in for Your Trust

For the last several years, and until the end of 2025, all the chatter out there for high-net-worth individuals is to lock in your $13.6 million Federal Exemption before it expires. But, with the benefit of 40 years of hindsight, and looking back on how my wealthy clients got hundreds of millions inside of “Green Boxes”, (Trusts that will not be subject to the Federal Estate Tax for anyone in the family and for up to 500 years) I have learned that more important then locking in the Exemption, is making significant gifts earlier in life and getting the growth and appreciation out of a “Red Box” (Trusts and Estates that will be subject to the Federal Estate Tax at each generation) and getting the growth into a “Green Box”. We have clients that have hundreds of millions in Green Boxes. How did they do it, especially when they did it, the Exemption was $5 million or less. This Article will examine the ways in which you can “Grow Green Boxes” and “Smoke Red Boxes”.

The Importance of Valuation

The first key is valuation. Take assets when they are at historic low values, such as “startups” or “depressed Real Estate” when the market is down, or depressed stocks when the Stock Market is down. Then, look for ways to get further “discounts” on the low values by “wrapping the assets” into an LLC or Family Limited Partnership. Gift away the non-voting interests in the LLC that owns the depressed real estate to get a 30% valuation discount for lack of control and lack of marketability. Transfer these low valued assets into a Green Box. If you have good appraisals to justify the valuation, the IRS has no argument. Do it now, this year. No time is better than now.

Maximize Your Federal Exemption

The second key is to use all your Federal Exemption right now. Don’t save it. The Exemption is much more valuable today with the depressed low discounted values of the Assets. We call this a “Squeeze”. You can “squeeze” $19 million or more in assets into a $13 million Exemption using a 30% discount, which is the national average. And remember, in the Spousal Lifetime Access Trust (“SLAT”) your spouse can be the Trustee and the beneficiary of these assets. You haven’t really given up much of anything if the marriage is solid. And next year, your spouse can create a SLAT for you and use up her Exemptions. These “reciprocal SLATs” cannot be created in the same year. So, you must do one this year and one next year to lock in both Exemptions before the “sunset” at the end of 2025.

Advanced Planning: The Freeze Technique

Now, if you are truly high net worth, then you have much more assets left in your Red Box after you have gifted your Exemption into the Green Box. Are you done planning? For most Estate Planners the answer is yes. No more planning for you. In a high net worth practice you are not done. You go to the “Freeze Technique”, and you sell discounted FLP or LLC units into a Green Box in exchange for a Promissory Note. Now the Red Box value is “frozen” in the value of the Promissory Note, and the appreciating assets, the winners, are in a Green Box. That’s a nice way to “grow green”. And this strategy is commonly called an “IDGT”. An Installment Sale to an Intentionally Defective Grantor Trust. That Article is coming soon if it isn’t already on our website.

Case Study: Estate Planning for a $70 Million Couple

Now, let’s take a Husband-and-Wife worth $70million in 2024, and let’s assume that in 10 years they double in value to $140 million. Very realistic for high-net-worth clients to double in 10 years. My experience is that they tend to double every 7 or 8 years. This client comes to our law firm, and we do the following steps:

2024, we wrap all investible assets in an FLP, and we get a 30% discount on top of whatever low depressed values we have.
1. First spouse creates a SLAT for 2^nd spouse and gifts $19 million of FLP assets into it using a 30% discount.
2025 – Second spouse creates a SLAT for spouse number 1 and gifts another $19 million into SLAT number 2 using up all that clients Exemption. Now we have $38 million that is Green and $32 million that is Red.
Also in 2025, Spouse One sells $12 million in assets to their own SLAT, number one and takes back a $12 million Promissory Note into the Red Box as their Sole and Separate Property.
Also in 2025, Spouse 2 sells $12 million in assets to their own SLAT, number two and takes back a $12 million Promissory Note.
When the dust settles at the end of 2025, we have $31 million in each SLAT number one and number two for $62 million that are in a Green Box appreciating in value. The Green Box at this point is only worth $38 million, because there are $12 million liabilities in each Green Box in the Promissory Notes.
We have $32 million of assets in a Red Box, $24 million of which are the two Promissory Notes “frozen” in value. And only $8 million in assets in the Red Box that are appreciating in value.

Looking Ahead: 10-Year Growth Projections

Ok now, lets fast forward 10 years and look at this client and see the value of the appreciation and growth inside of the Green Boxes.

Remember that each SLAT had $31 million ($19 million gifted and $12 million sold). Let’s assume that the $19 million assets doubled in 10 years to $38 million each, times 2 is $76 million. And the $12million in assets subject to the Note increased to $18 million each time 2 to $36 million. And the Notes were cut in half to $6 million each, times 2 is a liability of $12 million. So, the total net in the Green Boxes is $100 million.
Let’s assume that each Promissory Note was a 20-year Note, so after 10 years, half of the principal has been paid out to Red. So, each Note is now $6 million times two for $12 million liability. So, the net value of the Green Box is now $112 million, minus the $12 million in liability
In the Red Box we had $32 million in assets, $24 million in the Note not appreciating, and $8 million that appreciated. So, lets double that $8 million to $16 million, and now the total Red Box is $40 million.
Bottom line, $100 million is now Green and $40 million is Red.
Clients both die the next day, and the Estate Tax is 40% of $40 million so $16 million. The Kids inherit after Federal Estate Tases $124 million.

If the clients hadn’t followed these strategies, they both die with Red Boxes of $140 million. They now use their $14 million Exemptions (rounded up) so $126 million Taxable, and a Federal Estate Tax of $50.4 million. Kids inherit $89.6 million. Without the planning the kids inherit $34.4 million less. In either scenario, the clients both used their $26 million exemptions. But the client that used it 10 years earlier, along with the Freeze technique, gets an extra $34 million to the kids. That’s a great result.

Additional Strategy: The Washing Machine

As discussed in my other Article, “Squeeze, Freeze and Please”, the client can eliminate all Estate Taxes on the Red Box by doing the “Washing Machine”. (a TCLAT – a “Testamentary Charitable Lead Annuity Trust”)

The Swap Power: Enhancing Growth in Green Boxes

Another way you can grow Green and Burn Red is to insert a “Swap Power” inside of the Green Box and make it a “Grantor Trust” for Income Tax Purposes. This strategy accomplishes two things:

It eliminates any potential Capital Gains on the Freeze Technique when the client sells assets to a Green Box. It is like selling assets to yourself. The Green Box is now a Grantor Trust and is ignored for Income Tax purposes.
And, to help the appreciation inside a Green Box, lets suppose the client has another Start up Idea, but he doesn’t have the cash inside of the Green Box to do so. All assets are heavily invested. And let’s assume that the assets in the Green Box have “already had their run up”. Meaning a start up was transferred into the Green Box that sold for a 10 multiple in 10 years. And finally, lets assume the client has the cash needed to do the Start Up inside of the Red Box, and he will need $2 million dollars. So, what the client does is he swaps $2 million for $2 million. The $2 million in cash goes into the Green Box, and the $2 million worth of an asset that already has had its run up comes back to the Red Box. Now, 10 years later, the $2 million cash was invested into the Start up and blew up to $20 million. All Green. Where the asset that already had its run up, only went from $2 million to $4 million.
That’s really like doing another “Freeze Technique”. Assets in the Red Box grow slower than the assets put in the Green Box.

The Secret to Building Generational Wealth

Now you have the secret sauce. Now you know why some of our clients have hundreds of millions in Green Boxes. Mostly it is because of the compounded of the growth and appreciation inside of Green, and the “freezing values” inside of Red. Several of our clients own Professional Sports teams. We used the above strategies years ago, when we got low valuations for the teams, and then we wrapped the stock in the professional sports teams inside of a FLP to get further discounts. And then we gifted the non-voting interests in the FLP to the Green Boxes using up all our Exemptions. And then subsequently we sold assets to the Green Boxes using the Freeze technique. And, over the years, as the Red Boxes continue to grow, we come back and do another sell to the Green Boxes. Some of our clients have used this technique at least 3 times. We have clients today that have $50 million in Green Boxes that we started when the Federal Exemption was only $3.5 million, and that wasn’t that long ago. But, over the last 15 to 20 years, those assets inside of the Green Boxes has doubled and tripled. And most of these clients are down to zero inside of their Red Boxes. Not only have I studied these techniques, but I have implemented them for many clients and have seen the results. It is very rewarding in my career to see so much wealth pass free of Estate Taxes to the kids, and then on to the grandkids. So, remember to use that Exemption early and remember to “Grow Green and Smoke Red”

If you have any questions about how we can help you “make your gifts now” please call our office at 480-515-3716 or reach out online to schedule a free consultation.