2018 Tax Review

View Sand Hill's current assessment of the sweeping U.S. tax code overhaul signed into law in late 2017.

Charity Begins at Home

Charity Begins at Home

Earmarking the family home — or some portion of it — to fund a Charitable Remainder Trust (CRT) can satisfy philanthropic intent, reduce personal taxes, and generate long-term income. For those with certain needs and desires — coupled with the right set of circumstances and capabilities — this approach could be a better alternative than selling the property outright, or gifting it to the next generation via a QPRT or by some other means. And any resulting portion of the value of the home that donors might possibly withhold from charity, and instead keep for themselves (called retained interest), can still qualify for the generous available exclusion on capital gain on the sale of a primary residence (up to $250,000 per individual or $500,000 per married couple).

For years, many charities were reluctant, or simply unable, to accept any type of real property, despite the family-home long being the major single asset in most estates. Even now, many charities still have trouble dealing with various types of complicated real estate gifts; but many, if not most, charities are comfortable accepting single-family homes as donations. If certain smaller charities still have issues directly accepting such gifts — and donors still want to help them by utilizing this type of resource — then they could instead probably be able to gift their houses to larger community foundations or other more established non-profits. These organizations could, in turn, help coordinate multiple “remainder” gifts to multiple recipient charities.

Typically, donors use CRT’s because they are looking for a method to create an income source in exchange for their (full or partial) gift, and they often cannot afford to simply transfer the entire value of the home to the next generation as an inheritance. Alternatively, they often cannot afford to give it away completely to charity. They also cannot easily afford to take what is often a large tax hit of realizing substantial capital gain on what is usually a long-held home by selling it outright themselves to generate liquidity and net proceeds for their ongoing needs. Hence the relative attractiveness of CRT’s.

First of all, there are two types of CRT’s:

  • Charitable Remainder Annuity Trust (CRAT)
  • Charitable Remainder Unitrust (CRUT)

In a nutshell, the “Annuity” version pays a fixed and reliable dollar amount of income to the donor each and every year, while the “Unitrust” version pays the donor a fixed “percentage” each year based on the year-end value of the trust. By the way, additional contributions cannot be made to a CRAT, but they can be made to a CRUT.

Both of these charitable “remainder” vehicles provide for:

  • an immediate tax deduction for the donor (per AGI limitations noted below);
  • an income stream to the donor for a selected period of time (up to 20 years); and
  • an ultimate “remainder” gift to the charity (or multiple designated charities, if desired).

The amount of the tax deduction is limited annually as a percentage against adjusted gross income (AGI) by the type of donated asset, with an upper limit of 50% for cash gifts and typically only 30% for appreciated assets like stocks or real estate (such as primary residences or vacation homes). Alternatively, donors can elect to deduct just the associated cost basis of the gifted asset — if, for example, there has not been much appreciation — in which case this would allow an offset of up to 50% of AGI; but this approach is less common. Ultimately, any amount of available deduction that is not allowed can be carried-forward and similarly applied to future tax years for up to five years.

If an earmarked property is currently held at a loss, then there is no compelling reason to first give the house away to charity because that loss will be, well, lost. Instead, the owner should directly sell the house and realize the loss (to utilize now and/or carry forward to apply to future tax years), and then, give the resulting proceeds from the sale (or some portion of it) to charity using the same general logic as above.

[Note: there is also something called a Charitable Lead Trust (CLT), which also comes in similar available “versions” of annuity (CLAT) and unitrust (CLUT), and which offer many of the same basic features like tax savings. Indeed, the main difference is that CLT’s reverse the basic outcome and give the charity (or charities) a stream of income for a period of years and then pass the resulting remainder onto the chosen non-charitable beneficiary (or beneficiaries), such as young relatives of the donor. Prevailing interest rate considerations can also influence the decision of what format to use, and current low rates actually favor the CLT in some important respects for the donor’s benefit. However, this article only focuses on the CRT, and its ability to pay an income stream to donors. There is also something called the Charitable Gift Annuity (CGA) that enables similar income possibilities and avoidance of taxable gain, but different terms and conditions apply and this vehicle is also beyond the scope of this commentary.]

Within the realm of CRT’s, something called a FLIP CRUT is now typically the most common one used to provide income to donors when gifts of real estate are made, because provisions need to be in place for managing the possibility that the gifted property might take time to sell. Or, the donor might simply want to delay the receipt of income (for example, until their retirement). Typically, though, the triggering event is the sale of the property. Up until then, the trust might pay out a very limited income, but after the trigger (sale) occurs, it would become a standard CRUT. Around the San Francisco Bay Area, it is easy to think that all real estate sells quickly, though not always and not so in many other locations. Hence, the FLIP concept and its phased approach.

As noted briefly above, retained interest is another potentially compelling feature of utilizing the CRT. To accomplish this, donors assign some sort of fractional interest in the house that will ultimately go to the charity, and then keep, or retain for themselves, the resulting fractional interest. This retained amount will come back to them when the house is eventually sold. For many people,

  • this retained interest amount gets ideally calculated by trying to “back into” the most efficient use of the IRS Section 121 exclusion from capital gain on a primary residence.
  • this is the exclusion of gain of up to $250,000 (per individual) or up to $500,000 (per married couple) that is allowed on the sale of the primary residence, as long as the occupants have lived in the home for at least 2 of the past 5 years.
  • this exclusion can be repeated every two years, and this can apply to other existing long-held personal residences like a vacation home, if that property then becomes the new primary residence.
  • converting rental property for this purpose is possible, but depreciation recapture and other complex issues, plus any 1031 exchange considerations, are beyond the scope of this article.

The basic concept of donating a fractional interest in the value of one’s home is ultimately attractive to many donors because it can potentially enable them to maximize the tax-free gain on the sale of their home and yet in the process still benefit charity. It furthermore, and on top of that, establishes an income stream on an asset that previously did not provide any yield. Plus, they might have needed to downsize anyway, or move into some sort of assisted living arrangement.

Moreover — in the example of the married couple — if they wanted to, they could probably retain even more for themselves tax efficiently than strictly the $500,000 exclusion amount, because the resulting charitable donation will generate sizable tax deductions that could be used to help shield additional capital gain. Of course, the AGI limitations need to be carefully examined; and the potential effects of the Alternative Minimum Tax (AMT) also need to be taken into consideration.

As wonderful as all of this seems, there are some possible complications and other considerations to keep in mind, including the following:

  • Self-dealing problems: One cannot donate a home to a CRT and still live in it.
  • Pre-arranged sale: Donors should NEVER enter into a sales contract prior to gifting the house to the CRT. To be safe, don’t even engage a realtor. Donors do not want an effective sale to exist because the IRS will assume the donor is simply doing this to avoid gain; and thus, the donor could end up making an irrevocable gift and yet still owe capital gains tax.
  • No mortgage. This complicating factor can wreck the CRT and/or affect deduction.
  • UBTI (Unrelated Business Taxable Income): Charities must be very careful about something called UBTI, and this includes debt financed income. This can occur with acquisition indebtedness that has not been sufficiently aged. There are ways around it, and the current rules are less draconian than they used to be (when UBTI used to cause the whole entity to collapse), but this issue can still cause excise tax and other trouble, and thus it is best to avoid using any property that still has a mortgage on it. Ideally, pay off any debt prior to gifting.

Bottom line: the use of retained interests in gifts of primary residences to CRT’s offers attractive possibilities for many people — resulting in tax savings, income generation, and philanthropic satisfaction — and this approach could be the right “win-win” situation for many charitably inclined homeowners and the causes they support.

This article is for information purposes and does not contain or convey legal or tax advice. The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting with a lawyer and/or tax professional.

This information has been developed internally and/or obtained from sources that Sand Hill Global Advisors, LLC (“SHGA”), believes to be reliable; however, SHGA does not guarantee the accuracy, adequacy or completeness of such information nor do we guarantee the appropriateness of any investment approach or security referred to for any particular investor. This material is provided for informational purposes only and is not advice or a recommendation for the purchase or sale of any security. This information reflects subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. This material reflects the opinion of SHGA on the date made and is subject to change at any time without notice. SHGA has no obligation to update this material. We do not suggest that any strategy described herein is applicable to every client of or portfolio managed by SHGA. In preparing this material, SHGA has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision, you should consider, with or without the assistance of a professional advisor, whether the information provided in this material is appropriate in light of your particular investment needs, objectives and financial circumstances. Transactions in securities give rise to substantial risk and are not suitable for all investors. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.

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