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Friday, May 3, 2024
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Case Studies |
Living on the Edge, Part 3
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Case:
Rhea Jones, 75, lives in a beautiful coastal town in northern California. Rhea's home occupies three magnificent acres of bluff property overlooking the crashing waves of the Pacific. Since her home sits just steps away from the dramatic cliffs, Rhea frequently jokes to her friends about her "living on the edge" lifestyle.
John, Rhea's husband of 50 years, built the custom home 10 years ago. It was truly the realization of their lifelong dream. Unfortunately, John passed away unexpectedly five years ago. Now, Rhea lives alone in the large home. Nevertheless, she is looking forward to spending her remaining days in this lovely home. Not surprisingly, she frequently plays host to her children, grandchildren and friends.
Rhea is an active philanthropist. In fact, she spends three days a week volunteering with local charities. While very wealthy and philanthropic, Rhea makes only modest yearly gifts. However, she intends to make a substantial bequest upon her death. Specifically, Rhea plans on distributing her entire estate to her children and grandchildren, except for her cliffside home. Rhea's estate plan provides that the home passes to John and Rhea's favorite charity upon her death. The home is worth $13 million.
At a recent estate planning presentation, Rhea discovered the benefits of a gift of a remainder interest in a personal residence. In particular, she liked the potential significant tax savings and avoiding the estate administration process. Also, because the gift is irrevocable, the local charity would recognize and honor Rhea for her generous gift at the annual fundraising gala. Of course, Rhea would retain the right to live in her home for the rest of her life, which is an absolute requirement for any potential gift arrangement.
Question:
Rhea is very excited about this gift arrangement, but she has many questions for her attorney. Before she commits to the gift plan, she wants to address several questions. Her primary question is how is the charitable deduction set for a gift of a remainder interest in a personal residence?
Solution:
When calculating the charitable income tax deduction for a gift of a remainder interest in a personal residence or farm, the overall value of the contributed property must be divided between the land value (non-depreciable portion) and the building value (depreciable portion). There is no simple default rule for this division.
In some situations, the land value may far exceed the building value. For example, in San Francisco the land value may represent 3/4 of the overall property value and the building value may represent only 1/4 of the overall value. Alternatively, in another region, the land value may represent only 1/4 of the overall property value and the building value may represent 3/4 of the overall property value. Because no two properties are identical, each situation is unique.
Fortunately, a qualified appraiser or other qualified professional may provide such a determination. As a result, Rhea hires a qualified appraiser to determine the land and building value apportionment. (In addition, the qualified appraiser will determine the fair market value of the property. See GiftLaw Pro Chapter 1.5.2, "Form 8283 and Appraiser Qualifications.") After a thorough review, the qualified appraiser calculates the land value at $9 million and the building value at $4 million. This vital information is passed along to Rhea's advisor. Consequently, she moves one step closer to her gift planning goals.
Editor's Note: For gifts of a remainder interest in land only (i.e., no building), the overall property value is entirely land value and, accordingly, the building value is zero. On another note, some individuals use property tax records for determining land and building values. However, the IRS could challenge this alternative valuation because the tax record does not satisfy the qualified appraisal requirements. The IRS does not honor substantial compliance; it requires strict compliance to substantiate charitable contributions. Individuals should consult qualified counsel absent a written opinion from a qualified appraiser.
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