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Wednesday, May 1, 2024
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Case Studies |
A Bargain Sale with Insurance
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Case:
Chris and Caroline Peters, both age 60, purchased residential rental property ten years ago as an investment for their two children. They would like to one day transfer this home (or like value in cash or other property) to the two children as part of the children's inheritance. The home was purchased for $100,000 and is currently valued at $250,000. The outstanding mortgage on the property is $50,000 and their depreciated cost basis is $65,000.
Chris and Caroline have been active as volunteers in a local charity which deals in assisting primarily teen-age girls in crisis pregnancy situations. The charity has been desperately seeking additional housing to provide temporary living facilities to those girls during their pregnancy. Currently, the charity owns three houses and is hoping to purchase another two to three houses within the next year. There is currently a waiting list of ten girls needing the services of the charity so the need to purchase another home within the immediate future is great. Also, the charity has very limited resources with which to purchase the homes. Currently, donations are being solicited in earnest to meet this need.
Question:
The residential property owned by Chris and Caroline would be ideal for this purpose. It is a five bedroom home, in excellent condition and is located across the street from the charity's headquarters. They have discussed giving the home outright to the charity but their goal for the property has always been to provide an inheritance for the children. They have presented their dilemma to the charity's Major Gifts Director, Kathy Collins, and asked her whether or not she could come up with a workable gift scenario that would satisfy the stated objectives.
Solution:
Upon reviewing their objectives of using the property (or like value) as part of the children's inheritance along with their desire to give the home to the charity, Kathy stated that a combination gift/insurance scenario would be an ideal solution. First of all, the property would be transferred to the charity. Since the home is subject to a mortgage, Chris and Caroline would be allowed a charitable income tax deduction of $200,000 represented by the equity in the property. However, because of the bargain sale rules, they would be required to report a gain of $37,000 on the transfer of the mortgaged property to the charity.
Secondly, Chris and Caroline would create an irrevocable life insurance trust (ILIT) which would purchase a second-to-die life insurance policy on their lives. The net tax savings would be used to fund the trust. Transfer of the tax savings to the ILIT may be accomplished utilizing the annual gift exclusions via the "Crummey" power. Therefore, as long as the payments to the trust were $44,000 or less per year, no gift taxes would be due on these transfers to the trust. Also, since the trust owns the life insurance, the proceeds of the trust will pass to the children completely free of estate taxes.
Kathy went on to point out that Chris and Caroline may purchase any amount of life insurance via the ILIT that they desire. Whether or not they simply desire to replace the $200,000 gift to the charity or purchase additional insurance above this amount is their choice. It appears, in this case, that the net tax savings will purchase considerably more insurance than the $200,000 gift amount assuming, of course, that they are both healthy and will qualify for standard rates.
Chris and Caroline are very pleased with Kathy's recommendations. Through the gift/insurance combination, they are able to fulfill their charitable objective of providing their favorite charity with needed housing and, in addition, fulfill the estate planning objective of providing funds for their children's inheritance without estate tax consequences. This is truly an optimum arrangement for maximizing benefits to both family and charity.
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