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Thursday, May 2, 2024
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Case Studies |
Tax-Free $2 Million Home Sale
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Case:
Jack and Donna Bell, both 70, are retired geologists who lived and worked in Virginia their entire lives. They raised four children, all girls, in a beautiful, six-bedroom, 5,000 square foot home. However, the children moved out many years ago, and it is now just the two of them in the six-bedroom home. The upkeep and maintenance of such a large home has been very difficult for Jack and Donna to sustain. In addition, the cold Virginia winters have become increasingly harsher on Donna who suffers from a severe case of arthritis. As a result, Jack and Donna have reluctantly decided that it is time to finally sell the family home. They will then move to Florida where they could enjoy warmer weather and purchase a smaller, more manageable home.
During this time, Jack and Donna received a visit from their attorney and longtime friend, Catherine Wallace. Jack and Donna discussed the sale of their home, and the apprehension they had regarding "all the tax" they would have to pay. Their home was worth $2 million and had a cost basis of $300,000. Catherine informed them they could exclude $500,000 of the gain from the sale of their principal residence (under Section 121). However, the remaining $1.2 million of capital gains would be fully taxable.
Jack and Donna do not need all the sale proceeds at once, since their new Florida home costs only $250,000. In addition, they cringe at the thought of writing a check to the government for almost a quarter of a million dollars. Because it may take a while to find a buyer for such a large home, Jack and Donna also wish to remain in the home until it is sold.
Question:
The Bell's ask Catherine is there a way to avoid the capital gains on the sale of their home, and still provide them with at least $250,000 for the purchase of their new home. Also, can they remain in the home until the sale is completed?
Solution:
Catherine informed the Bell's that their solution could be a Charitable Remainder Unitrust ("CRUT"). The Bell's could transfer an undivided interest of their home into the CRUT, and retain the rest. When the property is sold, the Bell's would not have to pay any capital gains tax on the portion they put into the CRUT. With respect to the portion the Bell's sell personally, they would have to report the capital gains. However, the Bell's could apply their $500,000 exclusion and their CRUT generated charitable deduction to those capital gains. In particular, Catherine said the Bell's could arrange it so that zero tax would be due! The Bell's loved the idea, but wanted to see some numbers first.
Catherine returned later that week with some calculations. Based on a zero tax plan goal, Catherine informed the Bell's they could "cash out" $1,150,000 million without paying any capital gains tax! This result assumed they could use their $500,000 exclusion and their $307,000 charitable deduction. Furthermore, their CRUT would be funded with $850,000. They chose a 6% payout, which would pay out over $1.2 million over their two lives.
The Bell's were thrilled with Catherine's news. However, she did inform them that there was some bad news. While it was possible for them to transfer an undivided interest in their home into the CRUT, they could not transfer themselves, along with their house, into the CRUT as well. In other words, a donor is not allowed to have dealings with his CRUT property (Section 4941 prohibits self-dealing). As a result, it was very important that the Bell's move out BEFORE transferring an undivided interest in their home to the CRUT.
Despite the one piece of negative news, the Bell's were so swept away with the plan as a whole that they decided to create the CRUT nevertheless. Therefore, they moved out first, then made the transfer to the trust. About six months later, the home sold and the cash distributed to the Bell's and the CRUT. In the end, they used the self-dealing prohibition as a good excuse to move to Florida early. Selling tax-free is a decision the Bell's never regret, especially each year when winter rolls around.
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