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Sunday, May 5, 2024
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Case Studies |
Lead Trusts, Loans and Love for the Children
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Case:
Cameron Williams, age 60, is a successful general contractor who built a strip mall in the mid-1970s for $500,000. It is now fully depreciated and his depreciated cost basis in the property is $100,000, which represents the value of the land. The mall was recently appraised for $2.5 million and has been consistently generating a net income yield of 7.5% over the last 10 years.
Cameron is married to Susan and they have two children, ages 28 and 30. Because of his real estate background, their estate consists primarily of real estate. Cameron has made it a point to teach his children the ins and outs of investing in real estate and has been prudent to pass on his expertise in this area. Cameron and Susan's real estate holdings now exceed well over $7.5 million in value. They would like to pass some of their holdings to their children, but are quite concerned about the gift and/or estate taxes that would be assessed on such a transfer. Also, they are very concerned that the children are still too young to "handle" a large transfer of wealth.
Cameron is currently serving on the Board of his alma mater. In a recent Board meeting, he was informed that the university is in dire need of additional dormitory space for next year. The university does have some land on the north side of the campus on which to build the dorm, but the projected funds of $2.5 million are not available to build the building at this time. The Board considered entering into a capital campaign to fund the building, but time is of the essence. Therefore, they were considering borrowing the funds to build the dormitory. George Frederickson, a banker on the Board, stated that the university would probably be able to borrow the $2.5 million amortized over a 15-year period at an interest rate of 8.5%. Therefore, the annual loan payments would be right at $175,000. The Board president was quite hesitant to leverage the building unless a payment plan was in place prior to construction. Therefore, the decision was made by the Board to table discussions on this matter until the next meeting.
Question:
Cameron and his wife, Susan, were wondering if some gift method available to them could help the university build the dorm. Since they really did not need the income from the strip mall, perhaps they could use this property or the income therefrom to help fund this project. What method might be available to enable the university to fund the dorm?
Solution:
In discussing this with the university's Director of Gift and Estate Planning, Cameron and Susan stated that ideally they would like to use the property to help fund the dormitory project and also transfer it to the children in the next 15 or so years. The Director stated that the charitable lead trust would be an ideal vehicle to meet these objectives.
Cameron and Susan would transfer the strip mall to a 7% charitable annuity lead trust that would pay income to the university for a period of 15 years. The university could then use this $175,000 annual payment to make the payment on the bank financing. The trust would continue for a period of 15 years, by which time the loan would be completely amortized. At the end of the 15-year term, the strip mall would be transferred to the children. The children would then be 43 and 45, ages at which Cameron and Susan would feel comfortable with the children's ability to "handle" this substantial asset.
The value in making this gift via the lead trust is that Cameron and Susan will receive a charitable gift tax deduction of $1,614,218, resulting in a taxable gift of $885,783 to their children. Since they still have their full gift exemptions available, they will not pay any current gift taxes. No further gift and estate taxes will be due on any appreciation of the strip mall over the 15-year term. For example, if the property appreciates by 3% each year, the fair market value will be $4.0 million upon termination of the trust. The $1.5 million in appreciation will not be subject to any additional gift or estate taxes.
Cameron and Susan are very pleased with the lead trust concept. They are able, first of all, to make the gift that allows the university to build the dormitory. Secondly, they are able to express their love to their children by transferring to them an asset that will significantly enhance their financial position.
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