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Charitable remainder trusts and the property manager.

"I wish I could sell my property, but the taxes would kill me!"

Your client, frustrated by the years of minimal cash flow looks at you with a hopeful expectation for inspiration. "What can I do to generate some cash flow from this property?"

Enter the charitable remainder trust (CRT). The CRT has existed as a tax alternative to selling an asset for many years, but few real estate professionals have ever heard of it. Gaining a thorough understanding of the CRT will give you a financial disposition strategy that could save your clients hundreds of thousands of dollars (or millions for that matter), help a charitable institution provide valuable service to society, and solidify your position in your client's eyes as a true financial professional.

Understanding CRTs

The concept behind a charitable remainder trust is to avoid both income and estate taxes, while benefitting a charitable organization. Upon making a gift to an irrevocable CRT, the donor (property owner) is entitled to a charitable income-tax deduction in an amount equal to the present value of the future gift (remainder interest). This remainder value is generally determined by an IRS formula. Because the transferred property will often be sold by a not-for-profit charity, the sale is not subject to a capital-gains tax, and the donor/owner avoids any capital-gains taxation on the property.

In creating a CRT, the donor/owner gives the property to a charity, but retains the rights to income for his or her lifetime and that of a surviving spouse. Trusts may also be created for a specified number of years (no more than 20 years). This income is paid out to the donor/owner or to another designated party at least annually. By IRS regulation, this income must be at least 5 percent of the value of the donated asset. Upon the death of the donor or the end of the specified trust term, the remainder value reverts to the charity.

In fact, there are two basic types of CRTs - an annuity trust and a unitrust. Under an basic annuity trust, the donor receives a fixed amount each year; while under a unitrust, the donor receives a fixed percentage of the asset's annual value (based on an appraisal in the case of real estate). One or the other plan must be selected at the time the trust is drafted.

Once the property is donated, the donor/owner may serve as a trustee for that property and retain management control. However, no fee may be charged for this management service. Instead the donor/owner may elect to turn over management of the property to a third party.

In addition to enjoying the benefits of income from a CRT, donors of appreciable properties, such as real estate, may also take advantage of a wealth replacement plan to ensure that their heirs receive benefit from the donated property. Under such a plan, appreciated property is given to a CRT with the expectation that the property will be sold and the income will be reinvested in securities with a higher annual yield than the property.

At the same time, another (non-charitable) trust is established to benefit children or other heirs. This trust purchases a life insurance policy on the donor/owner, which will replace the value of the property that would have passed to the donor's heirs. The policy can be in any amount chosen by the donor/owner.

The income tax savings that result from the charitable gift and/or the increased after-tax income realized by the donor/owner is used to pay the premiums on the life insurance. When the donor/owner dies, the proceeds of the life insurance policy pass to the heirs without transfer tax.

A Case in Point

Your clients, Don and Sue Rey, are 67 and 64 respectively and own a multi-tenant industrial building. The value of the property is $2.2 million with no debt. Their desire is to no longer have the responsibility of property ownership and to provide a secure income stream for their futures and an inheritance for their children.

Under a standard sale, they would have capital-gains taxes to pay of $616,000 (see Figure 1). Investing the balance of $1,384,000 (assumes 9-percent selling cost) at 8 percent interest would yield an annual pre-tax cash flow of $110,720.

This same investment donated to a charity through a CRT would yield an annual pre-tax cash flow of $159,933 (assumes a projected income return of 8 percent). This is 44 percent greater annual cash than an outright sale, even after they have used $12,184 to purchase a $1 million life insurance policy for the benefit of their heirs. And this is only the beginning.

If an outright sale takes place, there will be estate taxes as well as capital-gains taxes to pay. In our illustration, an additional $692,000 will be paid upon the deaths of the Reys. No such tax occurs with a charitable remainder trust.

A New Option

Why then aren't CRT's more common in real estate transactions? Most people don't understand how they work. Universities have used them for many years to fund buildings and other programs, but if you asked 10 local brokers or property managers to explain a CRT, you might get only blank stares. Yet, managers and brokers are the people who control most real estate, so if they understand CRTs, they can offer a tremendous tax-saving vehicle to their clients.

It is important to keep in mind that very specific IRS rules must be followed both in establishing a CRT and in setting up a trust for wealth replacement. Also keep in mind that different rules apply to properties held by corporations or limited partnerships.

While a real estate manager should certainly inform owners of this option, the owner's attorney and accountant should be charged [TABULAR DATA FOR FIGURE 1 OMITTED] with the responsibility of setting up the necessary structures. Failure to follow all IRS rules correctly can lead to the disallowance of the trust and oblige the owner or beneficiaries to pay both gift and estate taxes.

If you want to learn more about this investment option, meet with a sophisticated charity in your community, and ask questions. You will be surprised at how many doors it will open for you and your clients. The next time you hear the anguished cry of "... taxes, what can I do?" remember the charitable remainder trust.

Richard A. Miller, CPM, is president and owner of Transtar Commercial Real Estate in Laguna Hills, Calif. Miller oversees the operations of a 5.5 million square-foot portfolio of commercial property in Southern California. As an advisory counsel member for The Estate Design Center at WestMed, Mr. Miller assists in bringing real estate expertise to the non-profit hospital's endowment program.

Craig A. Young is the staff attorney at The Estate Design Center at WestMed in Tustin, Calif. He received his J.D. degree from Western State University College of Law and has been licensed by the California Department of Real Estate since 1983. Young has served as a guest speaker at numerous Southern California seminars, appeared on a national financial talk show, and published several real estate articles.
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Title Annotation:New You
Author:Miller, Richard; Young, Craig
Publication:Journal of Property Management
Date:Jan 1, 1997
Words:1203
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