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Thursday, May 2, 2024
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Case Studies |
If You Sell It, The Benefits Will Come and Come and Come...
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Case:
Samuel and Sarah Wright, ages 72 and 70 respectively, live in a small farming community 30 miles west of Phoenix. For the past 40 years, they have farmed 130 acres of land. The land was inherited from Sarah's parents and, therefore, their cost basis in the property is about $100 per acre. Samuel and Sarah have five children, ages 40-50. Two of the children are teachers, one is a Minister of Music at a local church, one is a missionary and other is a farmer in the Tucson area. Each of them is married and they have ten children among them. Their children are good parents and hard workers, are civic minded and "make Mom and Dad proud."
Samuel and Sarah have toiled sun-up-to-sun-down for many years and are now very ready for retirement. They are fortunate that the suburbs of Phoenix have expanded around them; their farm is literally surrounded by housing and commercial developments. The 130-acre parcel sits on one of the corners of an intersection and real estate developers have expressed an interest in building a shopping center on the corner with a housing development on the back portion of the property. A number of developers have approached them about selling their property, but they just could not come to the decision emotionally to sell the acreage since the farm has been in the family for generations. Just recently they came to a peace in their hearts about this matter and now they feel the time has finally come to part with the farm.
In talking with a number of developers and real estate agents, Samuel and Sarah have been told that 25 acres of the property which front the intersection currently are valued at $50,000 per acre. This is a prime piece of property on which the developers would build the shopping center. The other 100 acres are projected to sell at $20,000 per acre and would be used primarily as tracts for new housing. Samuel and Sarah were absolutely astounded at these numbers, but thank goodness, this is reality!
Samuel and Sarah are both very charitable and feel that they were blessed with such wealth for a particular reason. Therefore, they would like to be good stewards of what they have been given and would like to use the farm property to make substantial testamentary gifts to a number of mission causes they have supported over the years. They have also recently made a pledge of $100,000 to the building program of their church and would like to use the property to fulfill the pledge.
Samuel and Sarah also have a number of financial objectives for themselves and their family. First of all, they would like to take $250,000 out of the property to relocate. Secondly, they would like to provide an income stream to themselves in the area of $75,000 - $80,000 annually for the rest of their lives. Thirdly, they would like to provide an income stream of $20,000 - $25,000 per year for each of their children's lives. Lastly, they would like to pay no capital gains or gift and estate taxes!
Question:
Can all of their financial and charitable objectives be realized?
Solution:
Over the past few years, Samuel and Sarah have been discussing their plans of selling the farm property with Ken Richards, the Director of Planned Giving at a Foundation which raises and manages funds for the mission causes they support. Ken told them, "Please see me prior to selling the property and don't sign anything!" He had hashed and rehashed their charitable and financial objectives in his mind and had come up with a plan that he was dying to share with them. When they finally came in and said they were going to go ahead with the sale and relocate, he already had done his homework. With impressive color charts and graphs, he laid out the following plan in front of them:
1) They would sell outright five acres of the corner (intersection) property for $50,000 per acre. This would give them the $250,000 to relocate. Since their personal residence sits on this acreage, the sale of the property should be subject to the $500,000 home sale exclusion and, therefore, no capital gains would be paid on the sale.
2) The remaining twenty acres of the corner property would be transferred into a 7.5% charitable remainder unitrust payable to Samuel and Sarah for their lifetimes. Therefore, the value of the trust would be $1 million. This charitable trust would begin in year one to distribute $75,000 per year. Distributions over the following years would most likely increase based on the assumption that trust earnings would exceed the 7.5% payout.
3) Five acres of the back portion of the property valued at $20,000 per acre would be given to the church to fulfill their pledge.
4) The remaining 100 acres would be evenly divided among five charitable remainder trusts for each of the five children. In other words, twenty acres would be transferred into each trust. Therefore, the value of each trust would be $400,000. The distribution percentage on each trust would be 5% and, therefore, each child could expect to receive an annual distribution beginning at $20,000 with likely increases to occur throughout their lifetimes.
After presenting the plan, Ken then went on to explain its many benefits. First, the financial objectives of lifetime income for themselves, cash to relocate, and lifetime income to each of the five children would all be realized. The charitable objectives of the pledge to their church and substantial testamentary gifts to their charities will be fulfilled. Second, no capital gains taxes will be paid on the sale of the property. Third, they will receive substantial charitable income tax deductions which can be used to offset a portion of the income distributions from their trust for the next six years.
Finally, because Samuel and Sarah are creating trusts for their children, a reportable taxable gift is being made to each child represented by the income interest of the trust. For example, on a child age 45, the income interest and thereby the taxable gift would be approximately $300,000 (based upon an Applicable Federal Rate of 6%). However, by using the annual exclusions and utilizing the lifetime exemptions of both Samuel and Sarah, no gift taxes would be due on the income interests created by the five trusts. Therefore, no gift or estate taxes would be due. However, they would be utilizing a good portion of their lifetime exemptions.
Samuel and Sarah were very impressed by Ken's presentation. Over the many years that they have farmed, the best year's crop only produced a net income to them of about $50,000 annually. And now, they were going to receive $75,000+ per year without even working! Also, they are able to give each of their children $20,000+ in income per year for the rest of their children's lives. They had never dreamed that they could help their children in such a substantial way. Finally, Samuel and Sarah wouldn't have to wait until they're gone to see the children benefit from their inheritance. This is a nice plan indeed that just keeps the benefits coming and coming and coming...
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