R.J.S., of Bayside, N.Y., asked me this question:

My wife and I receive our only income, besides Social Security, from the positive cash flow of our $2,000,000 rental property, owned Jointly. The building has no mortgage and is almost fully depreciated. We have no other savings. We have no life insurance and our son says this may be a good way for us to protect the building for our children's long term security. He says he will pay for it. Is this a good idea?

Dear R.J.S.:

Your son has an idea worth exploring. Let's look at some of the issues.

If you gift the building to your kids, any future appreciation is now out of you and your wife's estates. However, your kids will probably have large capital gains taxes to pay. And, you will owe an immediate Gift Tax liability of more than $340,000 (if you gift split with your wife). Let's look at another approach.

If you devise it to them from the surviving spouses estate, future appreciation will be included in the survivors estate. But capital gains will be reduced because basis will be "stepped-up" to the survivors date of death value. Importantly, Estate taxes will now be well over $625,000 and other estate costs may be over $100,000. Let's go one step further.

If you devise it to them from each spouses estate (first changing the ownership to Tenants in Common), future appreciation will be included in each spouses separate estate. Basis will be "stepped-up" to the date of death value of each spouse. Estate taxes may now be less than $300,000, especially with interim gifts of partial interests. Other estate costs may also be reduced. This seems like your best approach but how will your kids pay the estate settlement costs?

This is where your sons question is important. Insurance could provide cash for payments due. But, if you own the policy, or have any "incidents of ownership", like being able to change the beneficiary, the proceeds will be included in your estate and be taxed, and then you'll need more money, and additional proceeds might be included in your estate and taxed, and so on.

The costs, like filing fees and attorneys fees, will start right away. Taxes will be due within nine months of each spouses date of death. Putting a mortgage on the building may be hard to do, even if cash flow is sufficient to pay it. Selling the building under forced sale conditions often results in severe losses. Also, future income and growth will be lost.

If you use life insurance correctly, like in an Irrevocable Life Insurance Trust, you can provide for payment of costs due, when due, with the cash received tax free, essentially and simply keeping the building, whole, for your kids.

Remember, your son paying for the policy does not mean you have no incidents of ownership and that is a key to this procedure. To secure the results you intend, it's best to consult with a professional.

For more information on estate planning issues, pre- or post-mortem, contact my office or an attorney or other professional in your area who specializes in this field.