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Monday, August 19, 2019  Spokane, Washington  Est. May 19, 1883
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Tom Kelly: Charitable remainder trust as exit strategy

Defer tax on rental, but when must you pay?

Real estate investors, especially small-time players with one or two rental properties, may have more exit options available to them with a little research or a few conversations with a real estate attorney, financial planner or accountant.

For example, many investors choose to pay the tax on the sale of investment real estate rather than go through the process of a Section 1031 deferred exchange. While investors see the value of rolling all of their investment proceeds into the purchase of another investment property, the prevailing philosophy often is “I’ll have to pay the tax sometime, so I might as well do it now.’’

This exchange process, sometimes known as a Starker Exchange, has two stringent requirements. In order to defer the gain, the taxpayer must identify another “like kind” property within 45 days of the sale of the first property then close the transaction within 180 days of the sale of the first property.

The exchange was named after T.J. Starker, an Oregon man who made a deal with Crown Zellerbach in 1967 to exchange some of his forested property for some “suitable” future property. That agreement ended up in court. Starker’s battle was the basis for congressional approval of delayed exchanges.

What if you didn’t want to go through the exchange process … perhaps for a second or third time? What if you found a vehicle that could produce income, eliminated the pressure and responsibilities of management and the large chunk of cash that you would normally pay the Internal Revenue Service went to charity?

Take some time with a professional and investigate a charitable remainder trust as an exit strategy for a real estate asset that may bring you a huge tax bite if simply sold outright. A gift to a charitable remainder trust, or CRT, can produce significant income and gift tax charitable deductions for the donor plus a terrific benefit to the hospital, university, relief fund or senior shelter of your choice. There are thousands of charitable organizations in dire need of funds.

One personal financial specialist said a charitable remainder trust “is like giving away the tree yet keeping all the apples.’’

A CRT can be viewed as an irrevocable trust in which a portion of the trust’s value is distributed each year to one or more individuals for life or for a specific term. At the end of the term and when all the annual payments have been made, the designated charity has exclusive benefit of the property.

The annual amount paid to the donor is the result of a complicated formula. It involves actuarial tables similar to those used in life insurance. There are also minimum interest rate guidelines that apply once you determine the term of the trust or one’s life expectancy.

CRTs come in a variety of packages. The most popular form is the charitable remainder unitrust, or CRUT, which must each year pay out to a “noncharitable beneficiary” (perhaps you, your wife, family, friend, etc.) a fixed percentage of at least 5% of fair market value of the property. Additions to the trust can be made at any time. Because the value must be determined every year, the annual payments usually vary. There are special exceptions.

Another commonly used form is the charitable remainder annuity trust, or CRAT, which provides for an annual payment to a “noncharitable beneficiary” of a fixed amount of at least 5% of the original value of the property transferred to the trust. Because the amount of the annual payout is fixed at the time the CRAT is created, no additions can be made to it.

“I believe that a charitable remainder trust is an excellent – and sometimes overlooked – exit from real estate,’’ real estate attorney Bob Pittman said. “When an owner has exchanged over the years and now just wants out of real estate, the CRT can be an excellent tool to convert to a lifetime income stream, saving capital gains tax and receiving a charitable tax deduction.’’

Pittman said any reluctance to go the CRT route rather than leave valuable property to the estate can be alleviated through an insurance policy.

“The kids can be made whole through a special estate planning life insurance policy held in an irrevocable life insurance trust,’’ Pittman said. “The parents get more income, fewer headaches and a tax deduction. Their favorite charity gets the remaining asset and the kids get the life insurance. Only Uncle Sam is left out.’’

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