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Wednesday, May 1, 2024
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Case Studies |
Toxic Real Property, Part 1 of 3
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Case:
Diane Plant is a real estate broker and a savvy investor. Over the past twenty years, Diane has made a fortune investing in undeveloped commercial property. She will generally seek out and buy land on the outer limits of potentially high growth areas. Once the growth expands to her property, Diane will lease the land to incoming businesses, such as grocery stores and gas stations. This strategy has been wonderfully rewarding and successful. However, Diane is now nearing retirement and wants to transition out of her career. Therefore, she has decided to start selling her land holdings. Diane realizes the sale of her investments will produce a very large capital gains tax. Therefore, she would be very interested in options which would reduce her upcoming tax liability.
Recently, a local charity's gift planner approached Diane about making a large gift to support a capital campaign. The gift planner informed Diane that a large gift would produce a generous charitable deduction which could be used to offset her capital gains liability.
Diane is excited about this idea. She could greatly reduce her taxes and substantially help her favorite charity. In fact, she has the perfect property in mind to give. It is a two-acre lot in the heart of the city that has been used as a gas station for the past 15 years. It is worth approximately $500,000. Although excited about the size of the gift, the gift planner is nevertheless worried about the potential liability (i.e., environmental problems) associated with accepting the property.
Question:
How can Diane contribute the land to her favorite charity, yet provide liability protection for the charity?
Solution:
In a typical outright gift of real estate to charity, charity must take title to the property. Accordingly, charity will sell the property as soon as possible. However, charity will now be in the chain of title. Therefore, any environmental problems arising from the property could subject the charity to liability.
Instead, Diane could use a short-term charitable remainder unitrust to solve this dilemma. For instance, Diane would create a two-year net income plus makeup charitable remainder unitrust (NIMCRUT or NICRUT) with the $500,000 piece of real property. Diane, as trustee of the NIMCRUT, would then sell the property to a new buyer. Once the property is sold the NIMCRUT would have $500,000 of cash (minus selling costs), which could be invested in stocks and bonds for the duration of the trust term. Upon the termination of the two-year term, charity would receive the trust corpus. But more importantly, charity would never be in the chain of title with respect to the real property. Therefore, charity would benefit from the gift without exposing itself to potential future liability.
In addition, Diane would bypass all the gain from the sale of the land. Diane's charitable deduction would be approximately $476,000. Since Diane wanted to make an outright gift of the land, the fact that she will receive little, if any, income from the trust is not a deterrent. However, Diane's charitable deduction will be $24,000 less than if she made an outright gift of the property. Therefore, if income is desired, Diane could choose to create a 5% two-year CRUT with an annual payout. Thus, after the property has sold and at the end of year one and year two, the CRUT would distribute approximately $25,000 to Diane. This distribution could be used to pay for the costs of setting up the trust and to compensate for the slightly lower charitable deduction.
In the end, the short-term CRUT was an overwhelmingly successful solution. Charity was able to receive its much-desired gift but without the worry and expense associated with owning a gas station. Furthermore, Diane was able to make a substantial gift to her favorite charity while offsetting many of the capital gains realized from her other land sales.
Editor's Note: This case study assumes the property in question could be sold rather easily in two years. If the marketability of the property in question is uncertain, then the use of a three or four-year term CRUT would be advisable.
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