Providing updates and comments on Florida estate planning and creditor protection developments and insight for lawyers, CPAs, and other planning professionals

Welcome to this week’s Thursday Report, profiling “Swapback SCIN™” techniques and a new Florida case on homestead creditor protection

Each week we will provide a recent case or other development in summary form with analysis and ideas associated therewith. Please send us your ideas for future topics!

These reports are also posted on our website at gassmanlaw.com.

Also, wealthy married couples who are unsure how to take advantage of the $5.12 million gift estate tax exemption may want to take a look at our recent Article in Medical Economics.

We welcome all questions, comments, and suggestions and thank Stetson Law students Kacie Hohnadell and Allison Wallrapp for their efforts and dedication this week with state law research and analysis.

The “Swapback SCIN™” by Ken Crotty, Esq. and Alan Gassman, Esq.

Many clients are not aware of the practical benefits of converting an outstanding promissory note that is owed to him or her to a Self-Cancelling Installment Note (“SCIN”). A SCIN is a promissory note given from a buyer to a seller with a provision under which the obligation to make any future payments ends at the seller’s death.

Because the applicable lifetime gifting exclusion is scheduled to be reduced from $5.12 million to $1 million on January 1, 2013, it is important for clients to utilize this exclusion while it is still available. Many clients who are owed large promissory notes will find that gifting a portion of the principal owed and converting the remaining indebtedness to a SCIN will provide significant tax advantages.

The Trick

There are multiple ways that clients could potentially use SCINs to their benefit. The first option available to certain clients is to forgive or reduce amounts owed to the client under the promissory note. While some clients may be hesitant to forgive a large portion of a note owed to them and may fear losing the income stream from the note, establishing a SCIN can help alleviate these concerns by maintaining an income stream while still utilizing the lifetime gift tax exclusion.

Under this method, the promissory note would be divided into two separate notes. The client would forgive one note, thus allowing him or her to take advantage of the applicable gift tax exclusion, but the second note would still be owed to the client. The second note would then be converted from a regular promissory note to a SCIN. To take into account the risk that the note may not be repaid in full, the IRS requires a SCIN to have a higher interest rate. As a result, the interest premium payable on the SCIN would allow the client to receive interest payments equal to the interest paid on the original note even though the SCIN has a smaller principal value. Additionally, if the client dies before the end of the SCIN term, the value of the SCIN will not be included in the client’s gross estate.

This technique is illustrated by the following example for a 66 year-old client.  The client could convert the original note to a seventeen-year SCIN, which would need to charge interest at 4.586% based on the August 7520 Rate.  If the client was owed a $5 million promissory note bearing 2% interest, the note was paying the client $100,000 a year in interest.  The client could forgive $2,819,450 of the promissory note and retain a $2,180,550 SCIN.  At the higher interest rate of 4.586%, the SCIN would still pay the client $100,000 per year. Additionally, this would allow the client to utilize $2,819,450 of his or her increased applicable exclusion amount for lifetime gifts.

A second alternative available to clients seeking to take advantage of the SCIN is to gift the promissory note to a trust established for the benefit of the client’s spouse and/or descendants, and convert the remaining indebtedness to a SCIN. As described above, the original promissory note would be divided into two separate notes. The first note would be gifted to a Spouse and Family Exempt Trust (“SAFE Trust”), which would be established for the benefit of the client’s spouse and descendants. Again, the second note would be converted from a regular promissory note to a SCIN. In this scenario, the client would still receive interest payments from the SCIN equal to the amounts he or she received from the original note. In addition, the entity that owes the original promissory note would be required to pay interest to the SAFE Trust, either in cash or by transferring assets in kind.

On the client’s death, the promissory note owed to the SAFE Trust should not be included in the client’s estate, and assuming that the SCIN was maintained and structured properly, the principal amount owed on the SCIN would not be included in the client’s gross estate if the client died before the entire balance on the note was paid.

Thus, using the example above, a client owed a $5 million promissory note could gift $2,819,450 to a SAFE trust and retain a SCIN for $2,180,550.  Under the same August interest rate, the client would still receive $100,000 in payments from the SCIN. In addition, the entity that owes the original note would pay $56,389 worth of interest to the SAFE trust, assuming a 2.0% interest rate.

These examples demonstrate how clients can effectively utilize a SCIN to reduce their gross estate and take advantage of the increased gift tax exclusion while, at the same time, maintaining a steady stream of payments.

The Trap

There are, however, some limitations to these techniques. First, the term of the SCIN cannot be longer than the life expectancy of an average person of the client’s age. Additionally, these techniques may only be used if, at the time the arrangement is executed, the client has better than a 50% chance of surviving at least one year. Thus, these techniques work particularly well for clients who have a life expectancy that is less than the norm, but are expected to survive for at least one year following the execution of the SCIN.

Honing in on Homestead: Will a Leasehold Interest Qualify for Creditor Protection?

The maxim that “a man’s home is his castle” is deeply rooted in Florida’s jurisprudence; however, not all castles are created equal. Currently, Florida courts are in dispute over whether fee simple ownership is required to claim Florida’s homestead exemption from creditor claims. Recently, in Geraci v. Sunstar EMS,[1] the Second District Court of Appeal of Florida held that a long-term lease constituted “property owned by a natural person” under the Florida Constitution, Article X, Section 4, and thus qualified for homestead creditor protection. The court also specifically found that fee simple ownership is not necessary to claim this type of homestead protection.

In Geraci, the court considered whether a long-term lease of a condominium qualified for homestead creditor protection under Article X, Section 4 of the Florida Constitution.  The property at issue was a Pinellas County condominium that was the subject of a 100-year lease agreement from 1976.  The decedent, Mary J. Geraci, owned the leasehold interest, which had approximately 64 years remaining, and upon her death, creditors filed claims against her estate.  Lawrence Geraci, Jr., as personal representative of Mary Geraci’s estate, filed a petition with the court to determine whether the condominium qualified as homestead and thus was exempt from creditor’s claims.

The trial court had concluded that the condominium did not qualify for homestead creditor protection because it was subject to a lease agreement rather than being owned in fee simple. The Second District reversed, concluding that fee simple ownership is not necessary to claim homestead creditor protection.

Applying Article X, Sections 4(a) of the Florida Constitution, which grants homestead creditor protection, the Second District found that the condominium qualified as a homestead, despite the fact that it was not owned in fee simple. Specifically, the court stated as follows:

Article X, Section 4(a) does not distinguish between the different kinds of ownership interests that are entitled to the homestead exemption against forced sale. In re Alexander, 346 B.R. 546, 549-50 (Bankr. M.D. Fla. 2006); Cutler v. Cutler, 994 So. 2d 341, 344 (Fla. 3d DCA 2008); S. Walls, Inc. v. Stillwell Corp., 810 So. 2d 566, 571 (Fla. 5th DCA 2002). And the Florida Supreme Court has long since adopted the general rule that a fee simple estate is not necessary to this exemption. See Bessemer Props., Inc. v. Gamble, 27 So. 2d 832, 833 (Fla. 1946); Coleman v. Williams, 200 So. 207, 209 (Fla. 1941).

The court also noted that “any beneficial interest in land” may entitle its owner to the exemption.”Significantly, the court stated that the proper inquiry in determining whether a property qualifies for homestead creditor protection is whether: 1) the debtor intended to make the property his or her homestead; and 2) whether the debtor used the property as his or her principal and primary residence.

The Trick

As a result of the Second District’s Holding in Geraci, a debtor may be able to claim homestead protection for property that is not owned in fee simple. Some Florida decisions have permitted this exemption when the debtor has a long-term leasehold interest or an interest in a co-operative unit.

Similar Cases:

In Southern Walls, Inc. v. Stilwell Corp.,[2]the Fifth District Court of Appeal held that a co-operative interest qualified for homestead creditor protection. Specifically, the Fifth District stated that “a co-op must be a dwelling that an individual has an ownership interest in that gives him or her the right to use and occupy it as his or her place of abode.” The Fifth District further noted that the Florida Constitution does not define the term “owned” and that it “does not designate how title to the property must be held and it does not limit the estate that must be owned.”

Some Florida Bankruptcy Courts also agree that homestead creditor protection does not require fee simple ownership. In the case of In re McAtee,[3] the United States Bankruptcy Court for the Northern District of Florida found that a 99-year lease qualified for homestead creditor protection. The court stated, “During the life of a lease, the lessee holds an outstanding leasehold estate in the premises, which for all purposes is equivalent of absolute ownership.” Further, in the case of In re Dean,[4] the United States Bankruptcy Court for the Southern District of Florida found that a co-operative qualified for homestead creditor protection. Specifically, the court stated, “The availability of the homestead exemption is not dependent upon any strict or legalistic interpretation of the quality and nature of the property or of the quality of the debtor’s title. The Court must instead focus on the debtor’s intent to make the property his homestead and the debtor’s actual use of the property as his principal and primary residence.”

The Trap

Unfortunately, not all Florida decisions support the position that a debtor can claim homestead creditor protection absent an ownership interest; thus, there is no guarantee that a debtor will be successful when claiming this exemption for a long-term leasehold interest or an interest in a co-operative unit.

In the case of In re Lisowski,[5] the United States Bankruptcy Court for the Middle District of Florida sought to determine whether a debtor was entitled to claim homestead creditor protection under Article X, Section 4 of the Florida Constitution, which would disqualify him from claiming other Florida statutory exemptions. The court held that the debtor’s interest in a mobile home on leased land did not constitute an “interest in realty” for purposes of homestead creditor protection, thus he could not claim homestead protection under the Florida Constitution, but could claim certain statutory exemptions relating to mobile homes. The court held that homestead creditor protection only applies to “improved land or real property owned by a debtor, provided [that] the debtor’s residence is situated on the land,” seemingly interpreting Article X, Section 4 of the Florida Constitution to require ownership in order to qualify for homestead creditor protection.

In Phillips v. Hirshon,[6] the Third District Court of Appeal recognized the divergence in court opinions regarding whether ownership is required to claim homestead creditor protection and specifically stated, “[W]e respectfully submit that the courts may not diverge when interpreting the same subsection of the Florida Constitution, even if it seems to make good policy.” The court attempted to resolve the confusion among courts by certifying a question to the Florida Supreme Court, but the Court declined jurisdiction, leaving this issue unresolved.

Although the Second District in Geraci is not the first court to hold that a long-term leasehold interest may qualify for homestead creditor protection, this decision is significant because it strengthens the body of case law allowing homestead creditor protection absent an ownership interest.  However, other Florida decisions have found otherwise and not all courts may extend this form of homestead protection to interests other than fee simple ownership. Going forward, we can only hope that other courts will follow the guidance of the Second District in determining that fee simple ownership is not necessary to qualify for homestead creditor protection, or that the Legislature or Florida Supreme Court will step in and confirm that Floridians who have purchased a 99-year leasehold interest will have the same protection as their neighbors who have fee simple deeds.

NEWS AND UPCOMING EVENTS

August 6, 2012, 12:30 p.m. – 12:55 p.m.  Please join us for Lunch Talk, a free monthly webinar series with relevant topics for lawyers the first Monday of every month. To register please visit: www.clearwaterbar.org

August 13, 2012, 5:00 p.m. – 5:15 p.m. What Citizens Insurance Is Doing To Our Citizens (And You!).  Please join Chuck Wasson of Wasson Insurance and Alan Gassman, Esq. in a 15 minute webinar on Citizens Insurance Reduced Limits of Coverage.  To register please click here.

August 17, 2012, 8:30 a.m. – 4:30 p.m.  Nature Coast PAHCOM Chapter’s Hot Topics Seminar. Details and registration information can be found online at

www.naturecoastahcom.com/pahcom-events.html

August 23, 2012, 4:00 p.m. – 4:50 p.m. Please join us for The 4-4-4 Show, a monthly webinar series that qualifies for 1 hour of continuing education credit.  This month’s topic is “Tax Planning in an Election Year” with Ann Paxton, CPA of PDR Certified Public Accountants.  To register please visit: www.clearwaterbar.org

For details about each event, please visit us online at gassmanlaw.com/upcomingwebinars.html

Kenneth J. Crotty, J.D., LL.M., is a partner at the Clearwater, Florida law firm of Gassman, Crotty & Denicolo, P.A., where he practices in the areas of estate tax and trust planning, taxation, physician representation, and corporate and business law. Mr. Crotty has co-authored several handbooks that have been published in BNA Tax & Accounting, Estate Planning, Steve Leimberg’s Estate Planning and Asset Protection Planning Newsletters, Estate Planning magazine, and Practial Tax Strategies.  Mr. Crotty is also the author of the Limited Liability Company Chapter of the Florida Bar’s Florida Small Business Practice, Seventh Edition. He, Alan Gassman and Christopher Denicolo are the co-authors of the BNA book Estate Tax Planning in 2011 & 2012. His email address is ken@gassmanpa.com.

Thank you to our law clerks who assisted us in preparing this report:

Allison Wallrapp graduated summa cum laude from Rollins College and is currently a third-year student at Stetson University College of Law.  Allison serves as a representative in the Student Bar Association and is on the executive board of Stetson Republicans.  Her interests in the law include business law, employment law, and taxation.  Her email address is Allison@gassmanpa.com.

Kacie Hohnadell is a third-year law student at Stetson University College of Law and is considering pursuing an LL.M. in taxation upon graduation. Kacie is also the Executive Editor of Stetson Law Review and is actively involved in Stetson’s chapter of the Student Animal Legal Defense Fund. In 2010, she received her B.A. from the University of Central Florida in Advertising and Public Relations with a minor in Marketing, and moved to St. Petersburg shortly after graduation to pursue her Juris Doctor. Her email address is kacie@gassmanpa.com 

[1]Geraci v. Sunstar EMS, WL 2012 WL 2401793 (Fla. 2d DCA June 27, 2012).

[2]810 So. 2d 566 (Fla. 5th DCA 2002).

[3]154 B.R. 346 (Bankr. N.D. Fla. 1993).

[4]177 B.R. 727 (Bankr. S.D. Fla. 1995).

[5] 395 B.R. at 777 (Bankr. M.D. Fla. 2008).

[6]  958 So. 2d 425 (Fla. 3d DCA 2007).