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Wednesday, May 1, 2024
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Case Studies |
Toxic Real Property, Part 2 of 3
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Case:
Diane Plant, 60, is a real estate broker and a savvy investor. Over the past 20 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 over the next 10 years. 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.
At a recent tax planning seminar, Diane learned about charitable remainder trusts. She discovered the creation of a charitable remainder trust could produce a generous charitable deduction, increase her income and bypass capital gains. Diane is excited about this idea. She could greatly reduce her taxes and substantially help her favorite charity. Therefore, she contacts her favorite charity about her intentions. 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. The charity is very excited about the size of Diane's generosity. However, because the charity typically serves as trustee of CRTs if it is the remainderman, the charity is 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 and provide liability protection for the charity? Is there a way for her to "stretch" her charitable deduction out for more than the usual carryforward of five years?
Solution:
In an outright gift of real estate to charity or a transfer to charity as trustee of a CRT, the charity must take title to the property. Accordingly, the charity will sell the property as soon as possible. However, the 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 self-trustee her one-life CRUT (with a flip provision) to solve this dilemma. For instance, Diane would transfer the $500,000 piece of real property to herself as trustee. Diane, as trustee of the 5% payout CRUT, would then sell the property to a new buyer. Once the property is sold, the CRUT would have $500,000 of cash (minus selling costs), which then could be invested in stocks and bonds. Upon the sale of the real estate, the charity would then take over as successor trustee. Therefore, the charity is never in the chain of title with respect to the gas station. Accordingly, the charity would benefit from the gift without exposure to potential future liability.
In addition, Diane would bypass all the gain from the sale of the gas station. Moreover, she would receive a very nice income stream from the trust for the rest of her life. Finally, Diane's charitable deduction would be approximately $200,000.
Diane may further produce another charitable deduction in the future from her CRUT. In accordance with the rationale of PLR 9550026, Diane could transfer part or all of her income interest in the CRUT to charity. After the unitrust FLIPs to a standard payout method, the transfer of a portion of the income interest entitles Diane to a charitable deduction equal to the present value of her income stream. For instance, if Diane decides she no longer needs income from the trust six years from now, she could transfer her entire income interest (or a part of it) to charity. This transfer would produce another charitable deduction of $260,000, which could be used in the current year and carried forward up to five years. After six years have passed this gift will not be made to avoid the partial interest rules.
In the end, the CRUT (with a FLIP provision) was an overwhelmingly successful solution. The 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.
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