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Thursday, May 2, 2024
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Case Studies |
A CRT Solution for Real Estate "In the Zone"
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Case:
Wayne and Betty Ramsey own a 40-acre piece of property located on the outskirts of town which is zoned as agricultural property. Eight years ago, the county passed a controlled growth ordinance in which agricultural land could only be developed in accordance with a well-defined schedule as set forth in the ordinance. This ordinance was passed by a very slim margin in that year's election and was designed to prevent the urban sprawl which has occurred in other local communities. The primary aim of the ordinance was to protect the open spaces in the county which have been steadily disappearing over the past ten to fifteen years due to local development. The terms and conditions of the ordinance run for a period of ten years and, therefore, two years still remain before the Ramseys can sell their farmland to a real estate developer at a top dollar price.
The 40-acre parcel owned by Wayne and Betty is now subject to severe sales restrictions and must continue to be zoned as agricultural property for the next five years. Before the ordinance was passed, Wayne and Betty were negotiating with a local developer to sell the property for $25,000 per acre for a total sales price of $1 million. However, since the ordinance was adopted, the developer decided not to go forward with the purchase. Therefore, they made the decision not to market the property until the restrictions are lifted. However, their desire is to receive an immediate income stream from the property, but without a sale, this objective obviously cannot be achieved.
Wayne and Betty have been approached by their favorite charity to make a gift to an endowment campaign recently entered into by the charity. The charity hopes to raise $50 million in planned gifts consisting primarily of charitable gift annuities, charitable remainder trusts, charitable lead trusts and life estates. In talking with Patricia Baker, the charity's Gift Planning Officer, Wayne and Betty stated that they would like to use the property to fund a charitable remainder unitrust. They are fond of the many benefits of such a trust, as explained by Patricia, which includes lifetime income, bypass of the capital gains taxes and the charitable income tax deduction. However, because of the restrictions placed upon the property by the ordinance, the property would be difficult to sell at what they perceived as full fair market value. Furthermore, since income would not be available until the property was sold, the stated objective of current income would not be achieved.
Question:
Even with the restrictive conditions placed upon the property, Wayne and Betty would still like to fund the trust. Is there a way to fund the trust and still achieve their goal of receiving an immediate income stream from the trust?
Solution:
After the initial meeting with Wayne and Betty, Patricia stated that she and her staff would "get their heads together" and come up with a solution to this dilemma. Patricia had a reputation for thinking "outside the box" and has developed a number of creative solutions to prospective donor challenges such as this. After a brainstorming session with her staff, Patricia develops the following plan of action which is, once again, very creative.
The plan would involve Wayne and Betty transferring an undivided 90% interest in the property into a Type I or standard charitable remainder unitrust. The other 10% would be transferred to the charity as an outright gift. The charitable trust, of course, does not have any means for making the income distributions to Wayne and Betty. The way to solve this problem is for the charity to purchase a 10% interest in the property from the trust. Therefore, based upon the appraised value of $1 million, the charity would purchase a 10% undivided interest for $100,000. This money would then be used to make the income distributions to Wayne and Betty for the first two years. Assuming their desire is to receive at least $50,000 per year, a payout rate of 6.25% would be selected to provide them with the desired distribution ($800,000 x 6.25%). After two years, the restrictions imposed on development of the property will be lifted. Hopefully, during the next two years, the property will continue to appreciate in value and will sell for even more than the current $1 million value. This, of course, will result in increased income distributions to Wayne and Betty in the future.
This scenario not only provides nice benefits to Wayne and Betty, but to the charity as well. The primary benefit to the charity is that the financial risk is very minimal. With respect to the purchased value, since the charity has received a gift of 10% and purchased 10%, there would have to be a huge error in valuation in order for the charity not to receive its total cost, including interest, at the closing of the property sale. In all likelihood, the charity will recover the $100,000 plus any carrying costs and also receives a nice current gift as well.
Wayne and Betty are very pleased with Patricia's plan and her creativity. They will receive the income they desire currently, a "dual" tax deduction (based upon a current gift and a gift to the unitrust) and the satisfaction of knowing that they are making a very substantial contribution to their favorite charity.
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