Estate Planning for Commercial Real Estate

Why Is Estate Planning Critical for Commercial Real Estate Investors?

Estate planning for commercial real estate is the process of structuring your CRE holdings to minimize estate taxes, protect assets, and ensure a smooth transfer of wealth to the next generation. Without a deliberate plan, your heirs could face federal estate tax rates up to 40% on property values exceeding the current $13.61 million exemption (2025), potentially forcing them to liquidate assets at unfavorable prices just to cover the tax bill.

Commercial real estate creates unique estate planning challenges. CRE portfolios often involve multiple entities, complex capital stacks, ongoing debt obligations, and tenant relationships that require professional management continuity. A single misstep in titling, valuation, or entity structure can trigger millions in unnecessary taxes or legal disputes among beneficiaries.

The stakes are substantial. According to the IRS, real estate represents approximately 30% of all assets reported on estate tax returns, making it the largest single asset category subject to estate taxation. For commercial investors with portfolios valued above $10 million, combined federal and state estate taxes can consume 45 to 55% of portfolio value without proper planning.

This guide covers the essential strategies CRE investors use to protect and transfer wealth, including family limited partnerships, irrevocable trusts, stepped-up basis planning, valuation discounts, GRATs, QPRTs, and dynasty trusts. Whether you hold a single multifamily property or a diversified commercial portfolio, these tools can preserve significantly more wealth for your heirs.

How Do Family Limited Partnerships Protect Commercial Real Estate Wealth?

A Family Limited Partnership (FLP) is one of the most effective estate planning structures for commercial real estate investors. An FLP allows you to transfer ownership interests in your CRE portfolio to family members while retaining management control and capturing significant valuation discounts for gift and estate tax purposes.

Here is how an FLP works in practice. The senior generation contributes commercial properties to the partnership, typically retaining a 1 to 2% general partner interest that provides full management authority. The remaining 98 to 99% limited partnership interests are then gifted or sold to children or other heirs over time. Because limited partners have no control over management decisions and cannot freely sell their interests, the IRS allows valuation discounts that reduce the taxable value of each transferred interest.

Key Benefits of FLPs for CRE Investors:

• Valuation discounts of 25 to 40% on transferred interests due to lack of marketability and lack of control
• Retained management control through the general partner interest, even after transferring the majority of economic value
• Asset protection because limited partnership interests are harder for creditors to reach than direct property ownership
• Centralized management of multiple properties under one entity, simplifying operations and refinancing decisions
• Gradual wealth transfer that uses annual gift tax exclusions ($18,000 per recipient in 2025) to shift value over time

Example: You own a commercial office building appraised at $5 million. You contribute it to an FLP and begin gifting limited partnership interests to your three children. With a combined 35% discount for lack of marketability and lack of control, each 10% limited partnership interest is valued at $325,000 instead of $500,000 for gift tax purposes. Over several years, you can transfer the entire economic value while using substantially less of your lifetime gift tax exemption.

FLPs work best when combined with formal operating agreements, regular partnership meetings, and documented business purposes beyond tax savings. The IRS scrutinizes FLPs that appear to lack economic substance, so maintaining proper governance is essential. Review our guide on entity structuring for commercial real estate for related strategies.

What Role Does Stepped-Up Basis Play in CRE Estate Planning?

Stepped-up basis is one of the most valuable tax benefits available to commercial real estate heirs. When a property owner passes away, the cost basis of their CRE assets resets to fair market value at the date of death. This eliminates all accumulated depreciation recapture and capital gains that would otherwise be taxable upon sale.

For commercial investors who have held properties for decades while claiming depreciation deductions, the stepped-up basis can eliminate enormous embedded tax liabilities. Consider a warehouse purchased for $1 million twenty years ago, now worth $4 million. If the owner had fully depreciated the property to a $0 adjusted basis and sold during their lifetime, they would owe capital gains tax on $4 million plus depreciation recapture of approximately $1 million at 25%. The total tax bill could easily exceed $1.2 million.

With a stepped-up basis at death, the heir receives the property at its $4 million fair market value. If they sell immediately, they owe zero capital gains tax. If they hold the property, they begin a fresh depreciation schedule based on the $4 million stepped-up value, generating new tax deductions for the next 39 years.

Strategic Implications for Portfolio Planning:

• Properties with the largest gap between adjusted basis and fair market value benefit most from stepped-up basis
• Investors should consider holding highly appreciated properties until death rather than selling or exchanging them through 1031 exchanges
• Properties with significant remaining depreciation may be better candidates for lifetime transfers
• The stepped-up basis resets the depreciation clock, giving heirs 39 years (commercial) of new deductions

Use our DSCR calculator to evaluate whether holding or refinancing appreciated properties generates better cash flow than selling and reinvesting.

Important limitation: The stepped-up basis only applies to assets included in the decedent's taxable estate. Assets transferred to irrevocable trusts during the owner's lifetime generally do not receive a step-up, creating a critical planning tension between estate tax reduction and income tax elimination that every CRE investor must navigate carefully with professional guidance.

How Do Valuation Discounts Reduce Estate and Gift Taxes on CRE?

Valuation discounts are the cornerstone of most CRE estate planning strategies. When commercial real estate is held through entities like FLPs, LLCs, or trusts, the IRS permits two primary discounts that can reduce the taxable value of transferred interests by 25 to 45% below the underlying property value.

Discount for Lack of Marketability (DLOM): Limited partnership or LLC membership interests cannot be sold on a public exchange like stocks. Finding a buyer for a minority interest in a private real estate entity requires significant time, effort, and transaction costs. This illiquidity justifies a discount typically ranging from 15 to 25%.

Discount for Lack of Control (DLOC): A minority interest holder cannot force a sale, make distribution decisions, select tenants, or direct property management. This lack of control reduces the value a hypothetical buyer would pay, justifying an additional discount of 15 to 25%.

Combined discounts typically range from 25 to 40%, depending on the specific restrictions in the partnership agreement, the nature of the underlying assets, and the quality of the supporting appraisal.

Example: A commercial portfolio valued at $20 million is held in an FLP. A 30% limited partnership interest has a pro-rata value of $6 million. With a combined 35% valuation discount, the gift tax value drops to $3.9 million, saving $2.1 million from the taxable transfer amount. At a 40% estate tax rate, this discount preserves $840,000 in wealth for the family.

The IRS has repeatedly challenged aggressive valuation discounts, particularly through proposed regulations under Section 2704. CRE investors should obtain qualified appraisals from accredited professionals (ASA or MAI designated) and ensure their entity agreements include genuine restrictions that support the claimed discounts.

What Are GRATs and How Do They Transfer CRE Wealth Tax-Free?

A Grantor Retained Annuity Trust (GRAT) is an advanced estate planning technique that allows CRE investors to transfer property appreciation to heirs with minimal or zero gift tax exposure. GRATs are particularly effective for commercial properties expected to appreciate significantly, such as value-add acquisitions or properties in rapidly growing markets.

You transfer commercial property into an irrevocable trust and retain the right to receive annuity payments for a fixed term, typically 2 to 10 years. The annuity payments are calculated using an IRS-prescribed interest rate (the Section 7520 rate). If trust assets grow faster than this hurdle rate, the excess appreciation passes to your beneficiaries gift-tax-free.

Zeroed-Out GRAT Strategy: Most CRE investors use "zeroed-out" GRATs where annuity payments equal the full value of the transferred property plus the Section 7520 rate of return. This results in a taxable gift of approximately zero while capturing all excess appreciation for beneficiaries.

Example: You transfer a $5 million commercial property into a 5-year GRAT when the Section 7520 rate is 5.4%. The trust pays you approximately $1.15 million annually ($5.75 million total). If the property appreciates to $8 million and generates $400,000 in annual rental income, the trust can fund annuity payments from cash flow and appreciation. The remaining value (approximately $2.25 million plus excess income) passes to your heirs completely free of gift and estate taxes.

Best CRE Candidates for GRATs: Value-add properties with significant upside, recently refinanced properties with strong cash flow, and assets in rapidly appreciating markets.

Risks: If the grantor dies during the GRAT term, trust assets are included in the taxable estate, eliminating the benefits. For this reason, investors typically use shorter terms (2 to 3 years) and "roll" assets into successive GRATs. Schedule a consultation to discuss whether your portfolio's cash flow profile supports a GRAT strategy.

How Do Dynasty Trusts and QPRTs Work for Real Estate Investors?

Dynasty trusts and Qualified Personal Residence Trusts (QPRTs) are specialized estate planning vehicles offering significant tax advantages for commercial real estate investors with substantial portfolios.

Dynasty Trusts hold wealth for multiple generations, potentially in perpetuity, while avoiding estate and generation-skipping transfer (GST) taxes at each generational level. For CRE investors, a dynasty trust can hold commercial properties or entity interests for 100 years or longer (depending on state law), with each generation benefiting from rental income and appreciation without triggering estate taxes.

Key Dynasty Trust Benefits for CRE Investors:

• Multi-generational tax avoidance because assets are not included in any beneficiary's taxable estate
• Asset protection from creditors, divorcing spouses, and lawsuits
• Professional management continuity through a designated trustee or trust company
• Flexibility to buy, sell, refinance, and manage commercial properties within the trust
• GST tax exemption when funded within the lifetime exemption ($13.61 million in 2025)

State selection matters for dynasty trusts. South Dakota, Nevada, Delaware, and Alaska offer the most favorable provisions, including no state income tax on trust income and no rule against perpetuities. CRE investors should consider establishing trusts in these jurisdictions even if their properties are located elsewhere.

Qualified Personal Residence Trusts (QPRTs) allow you to transfer a personal residence or vacation property to heirs at a deeply discounted gift tax value. You transfer the property to an irrevocable trust while retaining the right to live there for a specified term (typically 10 to 15 years). The gift tax value is reduced by the retained interest, often resulting in discounts of 40 to 70% depending on the term and the grantor's age at transfer.

What Does a Commercial Real Estate Succession Plan Include?

Succession planning for commercial real estate goes beyond legal documents. It requires a comprehensive operational roadmap that ensures your portfolio continues to generate income and appreciate in value after your involvement ends.

Essential Components of a CRE Succession Plan:

1. Management Transition Framework. Identify and train successors for property management, tenant relations, and capital improvement decisions. Document all vendor relationships, maintenance schedules, lease terms, and operating procedures. If family members lack expertise, establish relationships with professional property management firms.

2. Debt Management. Catalog all existing mortgages, lines of credit, and loan covenants. Many commercial loans include "due on death" or "change of control" provisions that could trigger immediate repayment. Consider refinancing existing debt to remove problematic provisions before they become urgent.

3. Entity Documentation. Maintain current and accessible records for all LLCs, partnerships, and trusts. Include operating agreements, partnership agreements, trust instruments, and organizational charts showing ownership percentages. Your successors should be able to understand the entire ownership structure quickly and completely.

4. Capital Planning and Tax Review. Document ongoing improvement plans, deferred maintenance items, and reserve fund balances. Ensure property tax appeals are current, insurance coverage is adequate, and capital gains tax strategies are documented for each property.

Contact our team to discuss how your financing structure supports or complicates your succession plan.

How Do You Choose the Right Strategy for Your CRE Portfolio?

Selecting the right estate planning strategy depends on portfolio size, family dynamics, investment timeline, and tax situation. Most comprehensive plans combine multiple strategies.

Portfolio Under $13.61 Million: Focus on stepped-up basis planning and basic entity structuring. Hold appreciated properties in your taxable estate to capture the full basis step-up at death. Use LLCs and operating agreements to simplify management transitions.

Portfolio of $13.61M to $30 Million: Implement FLPs or family LLCs to capture valuation discounts. Use annual gift tax exclusions to gradually transfer limited partnership interests. Consider a zeroed-out GRAT for your highest-growth properties.

Portfolio Over $30 Million: Deploy the full suite of strategies, including dynasty trusts funded with discounted entity interests, rolling GRATs, irrevocable life insurance trusts (ILITs), and charitable strategies. Engage a coordinated team of estate planning attorneys, CPAs, and commercial real estate advisors.

Use our commercial mortgage calculator to model how different financing structures affect your estate planning options.

Frequently Asked Questions About Estate Planning for Commercial Real Estate?

What is the federal estate tax rate on commercial real estate? The federal estate tax applies at rates up to 40% on taxable estates exceeding $13.61 million per individual ($27.22 million for married couples) in 2025. Properties held through entities may qualify for valuation discounts reducing the taxable amount.

Can I transfer commercial property to a trust without triggering capital gains tax? Transfers to revocable trusts and grantor-type irrevocable trusts (including GRATs) are generally not taxable events. Transfers to non-grantor irrevocable trusts may trigger capital gains. Consult a tax advisor before transferring appreciated CRE assets.

How does the 2026 estate tax exemption sunset affect CRE investors? The TCJA doubled the exemption, but it may revert to approximately $7 million per person after 2025. Investors with portfolios between $7 million and $13.61 million should accelerate wealth transfer strategies before any reduction takes effect.

Do I need a separate entity for each commercial property? Not necessarily, but separate LLCs provide liability isolation, simplify transfers, and allow targeted gifting. A common structure places individual property LLCs under a parent FLP. See our entity structuring guide for recommendations.

What happens to commercial property debt when the owner dies? Non-recourse loans stay with the property. Recourse loans may require payment from the estate. Many lenders include "due on death" provisions that are often waivable for family transfers. Review loan documents and consider refinancing to remove restrictive clauses.

How often should I update my CRE estate plan? Review annually and update after acquisitions, dispositions, refinancings, family changes, or tax law changes. Major portfolio changes should trigger an immediate review with your estate planning attorney and CPA.

Can a GRAT hold leveraged commercial property? Yes, but the annuity must account for debt service. Properties with strong cash flow after debt service, such as stabilized assets financed through permanent loans, are the best GRAT candidates.

Is life insurance important for CRE estate planning? Life insurance held in an irrevocable life insurance trust (ILIT) provides liquid funds to pay estate taxes without forcing property sales. This is especially valuable for illiquid CRE portfolios where selling assets quickly would result in discounted prices. The insurance proceeds remain outside the taxable estate when properly structured.

Sources and References?

1. Internal Revenue Service, "Estate Tax" and "Instructions for Form 706," IRS.gov, 2025.
2. American Bar Association, "Estate Planning for Real Estate Investors," ABA Real Property Section, 2024.
3. Urban Institute and Brookings Institution, "Tax Policy Center Briefing Book: Estate and Gift Taxes," taxpolicycenter.org, 2025.
4. National Association of Realtors, "Commercial Real Estate and Estate Tax Policy," NAR Research, 2024.
5. Journal of Financial Planning, "Valuation Discounts for Family Limited Partnerships," 2024.

This guide is for educational purposes and does not constitute legal or tax advice. Estate planning for commercial real estate requires qualified legal, tax, and financial professionals. Contact Clearhouse Lending to discuss how your financing strategy integrates with your estate plan.