Tax advantages of an Alaskan vacation home

Tax and Trust Law Advantages in Alaska

Introduction

Alaska has some of the most favorable tax, trust and asset protection laws in the country.  These advantages are available to people who maintain their Alaska residency and to non-residents who own property in Alaska and elect to utilize Alaska trusts or business entities.

The following information is provided by the Alaska law firm of Foley & Foley, P.C., and is intended to provide a general overview that illustrates some of the benefits of Alaska residency and Alaska law.  This information should not be considered legal or tax advice.  For a full explanation of how you can take advantage of Alaska’s favorable tax and trust laws, you should contact a qualified Alaska attorney.

Low Taxes

Alaska residents enjoy some of the lowest taxes of any state or region in the country.  This is because Alaska has no income tax and because sales taxes are limited to certain geographic locations of the state.  Property taxes are also relatively low in Alaska.  Studies show that Alaskans live in one of the two or three least-taxed states in the country.

Alaska Permanent Fund Dividend

In addition, Alaskans who maintain their residency and are present in the state for at least 180 days per year qualify to receive the annual Alaska Permanent Fund Dividend, which is a share of the earnings of the Alaska State Permanent Fund.  This fund, which is currently valued at over $38 billion, holds a portion of Alaska’s royalties from oil and gas production in the state.  The fund has generated an average of over $1,400 per year per resident over the past 10 years.

State Death Taxes

Twenty-four States* and the District of Columbia have implemented estate or inheritance taxes, sometimes simply referred to as DEATH TAXES. Individuals who die as residents of these states may be required to pay state death taxes in addition to any federal estate tax payable as a result of their deaths.  Alaska does not have an estate or inheritance tax and individuals who are residents of the State of Alaska when they pass away will not be subject to these additional state death taxes.

Locating your primary residence in Alaska may mean lower taxes during your lifetime and less death taxes, as well.

*Connecticut, Illinois, Indiana, Iowa, Kansas, Kentucky, Massachusetts, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Vermont, Virginia, Washington.

Alaska is the only state that has an “opt in” community property statute.  This law allows married couples who are residents and non-residents to take federal income tax benefits of community property. When property is held as community property under the law of any state, the surviving spouse can avoid capital gains taxes on the sale of the real estate.  You do not need to become Alaska residents to take advantage of this law, but owning Alaska property can enhance a non-resident’s standing to use the Alaska law.

When you sell appreciated real property, the Internal Revenue Code imposes a tax on the difference between the “basis” (cost of property less depreciation) and the sale price.  When real estate is held by a married couple as “community property,” the surviving spouse receives a full adjustment in the basis to fair market value of the property.  When the property has appreciated, this is called a “step up” in basis.  This means that capital gains taxes can be avoided on the sale of assets that have appreciated before the death of the first spouse if those assets are owned as community property.  There are ten community property states.* Couples who do not live in a community property state can put property into an Alaska Community Property Trust while both of them are alive and receive this special tax treatment on the death of the first spouse. To qualify, the property must be owned in the Alaska Community Property Trust before the first spouse dies.

It is not necessary to own Alaska real estate to take advantage of this Alaska law, but many estate planning attorneys recommend that non-residents hold at least one piece of Alaska real estate in their Community Property Trustto assure the best advantages of the Alaska Community Property Law.

*Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Alaska has some of the strongest asset protection laws of any state.  Alaska residents and non-residents may take advantage of these laws by establishing trusts, partnerships, corporations or limited liability companies (LLCs) under Alaska law to hold real estate or other financial assets or personal property.  The best option for you depends upon your particular circumstances.  The following is a sampling of asset protection opportunities under Alaska law.

Qualified Personal Residence Trust (QPRT) 

An Alaska qualified personal residence trust (QPRT) is an excellent way to reduce federal estate taxes and also provide asset protection for an Alaska residence.  The residence may be a primary or secondary home.

For example, let us assume that you own an Alaska residence with a fair market value of $400,000. Assume you are 60 years of age and that the residence appreciates 4% per year until your death at age 81, which is your actuarial life expectancy.  Without using a residence trust, at the date of death when you are 81, the residence will be worth $925,253. If your estate is taxable and rates are the same as they are today (2008) , the federal estate tax will be about $425,617.

If you transfer the same residence to a QPRT today and reserve the right to live in the home for 15 years, IRS tables direct that the deemed current value of the gift would be about $160,000.  You will need to report this gift to the IRS, but no gift taxes will likely be due at the time that the trust is created unless you have already made substantial taxable gifts.  Moreover, if you live more than 15 years, the entire value of the home will not be includable in your estate, which would result in over $425,000 in tax savings at current federal tax rates if you live to your life expectancy.

In addition to the potential estate tax savings, Alaska law provides that an Alaska residence that has been placed in an Alaska QPRT is protected against claims of your future creditors.  Such creditors might decide to bring a lawsuit against you because of a bad commercial transaction, professional malpractice, a personal injury accident or a future marriage and divorce.  The protection of personal residences in an Alaska QPRT applies no matter how large the value of the residence.

If your residence is sold by the trust during the period of time when you are entitled to use the residence, the trust has two years to use the proceeds to buy a new residence for you to live in. If instead you decide not to purchase a new residence, you will be paid an annuity for the rest of the trust term (15 years in the example above).

Alaska QPRTs require at least one trustee that is either an individual resident of Alaska or a bank or trust company that is organized under Alaska law.

Alaska Self-Settled Spendthrift Trust

Alaska is one of the few states that allow you to create a trust for your own use and benefit and at the same time protect the trust assets from claims of your future creditors.  Such trusts can be created by residents and non-residents of Alaska.  Such trusts are called Self-Settled Spendthrift Trusts.

If you own Alaska commercial or rental property that you want to protect from creditors, you can establish an Alaska Self-Settled Spendthrift Trust and transfer the property to the trust.  Such trusts require that there be at least one trustee (other than yourself) who is either an individual resident of the state of Alaska or a bank or trust company organized under Alaska law .

Another benefit of a self-settled spendthrift trust is that trust property should not be a part of your taxable estate when you die.  If your Alaska property is worth $400,000 today, but appreciates to $800,000 at the time of your death, the entire value would not be included in your taxable estate, saving in excess of $350,000 under current tax rates.

Alaska Limited Liability Companies (LLCs)  

Alaska has very favorable laws regarding the protection of assets held by limited liability companies (LLCs).  Many people establish LLCs to hold their commercial or rental property .  The State of Alaska charges only $250 to file Articles of Organization for an LLC and requires ongoing payments of $100 every other year to maintain the LLC.  These fees are well below the cost of creating and maintaining similar business entities in other states.

Alaska law also provides that if a creditor sues you and obtains a judgment against you, your membership interest in the LLC cannot be sold or liquidated for the benefit of the judgment creditor.  Moreover, such creditors are not allowed to take over and control or operate the LLC.  Such creditors are only entitled to a “charging order” from the court which is the right to receive annual distributions from the LLC.  If no money is distributed by the LLC, the creditor does not receive any money.  This legal protection under Alaska law allows LLC owners the potential to negotiate more favorable settlements with creditors.

When property is held by the LLC, the LLC owners are also shielded from claims by people who rent or use the property and who might suffer injury on the property.  Such claimants can recover from property liability insurers or force a sale of the property itself to satisfy a claim.  But the LLC owner is protected from claims for any damages in excess of liability insurance and the value of the property by people who are injured while coming onto the property.

Conclusions    

All of the examples and strategies identified here should only be implemented with the assistance of a qualified attorney after review and counseling to assure that the strategy fits your particular circumstances.

Pursuant to CIRCULAR 230, unless otherwise expressly indicated, any tax advice contained in this communication is not intended and may not be used for the purpose of avoiding tax-related penalties under the Internal Revenue Code.