Whatcom County Commercial Real Estate
Making Income From Your Property Without Management Responsibilities
Question: I have property that has appreciated in value over the past 25 years. I would like to convert the property to some sort of income without the management responsibilities, but I do not want to pay the capital gains tax. Any suggestions?
Answer: This is a common question, especially with the recent run-up of real estate values in our area.
Individuals with highly appreciated land and/or rental properties are looking for a ways to convert their properties to income without the consequence of a large tax liability. Landlords often want to simplify their lives by getting out of the rental business, but also want to retain their same level of income.
One solution may be a charitable remainder trust. A charitable reminder trust allows an individual to transfer their property to the trust and convert the real estate value to cash and eventually to income without the usual tax liabilities.
The general process would involve the establishment of a charitable remainder trust with the help of a qualified attorney. The property title would then be changed so that the trust owned the property. The property could then be sold inside the trust and the cash converted into income.
There are a few different ways to receive the income from the trust, depending on your age and objectives. The attorney, financial planner and/or qualified CPA would know these options. Generally, the income would last your lifetime and/or the lifetime of your spouse.
You would identify a qualified charity and/or quailed nonprofit organization to receive the remainder of the trust assets at the death of the lasts identified income recipient.
There are several advantages to this type of process. The tax liability is gone; you have an income for life; and you are allowed an income tax deduction because you have donated the property and the cash assets to a charitable organization. The money that would have gone to federal and state taxes will now goes to the charity of your choice upon your death. In addition, you can serve as your own trustee to your charitable remainder trust and have some control over the investments in the trust.
The disadvantage is the fact that you no longer own your real estate once it is converted to cash inside of the charitable remainder trust. There will be no property to pass on to heirs because you have converted it to income.
Individuals who are seeking income and have no sentimental attachment to a real estate may want to consider this option. It is important to seek the proper professional advice with a qualified attorney, CPA and financial planner.
Question: I like the idea of a charitable remainder trust, but I do not like the idea of leaving my children without the real estate (and its value) that I might transfer into the trust. Are there any options that would give me current income and also leave something to my heirs?
Answer: Yes, it is something called a Wealth Replacement Trust
Individuals can take advantage of the charitable remainder trust idea with attractive tax benefits and a guaranteed lifetime income. In many cases, the tax deduction allowed for the charitable gift will net more income for the recipient. This extra income can be used to fund a life insurance policy for the benefit of the heirs to replace the cash value of the real estate that was transferred into the charitable reminder trust.
For example, if the real estate value was $250,000 a life insurance policy would be established for $250,000 for your heirs. The policy should be established in an irrevocable life insurance trust or it can be originally owned by our heirs. You do not want to have any ownership of the life insurance in that the death benefit will be included in your estate at your death.
Cash would be gifted to the trustee of the irrevocable life insurance trust or to your heirs. They would have the option of paying the premiums. You cannot require them to pay the premiums because this would give you an element of control over the policy.
The irrevocable life insurance trust should contain something called a Crummy provision so that you are not directly linked to the payment of the insurance premium. The provision stems from a lawsuit in which one of the party’s last names was Crummy.
A qualified attorney, financial planner or CPA will know how to set up these programs properly.
Upon your death, the insurance proceeds will pass to our heirs without probate, without estate tax and without income tax.
Often a married couple will use a second to die insurance policy that will cover both individuals on the same policy. This can be less expensive and will pay the heirs at the death of the second individual.
Blain Hardy is a Certified Commercial Investment Member in Bellingham. He can be reached at 360-714-1080. |