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Wednesday, May 8, 2024
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Case Studies |
An Installment Purchase with Nothing Down and No Principal Repayment
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Case:
Lynne Thompson, age 60, owns an apartment building that she purchased a number of years ago for $200,000. The fair market value of the building is now $500,000 and her depreciated cost basis (based on straight-line depreciation) is $100,000. She no longer desires to manage the property and would like to sell. However, she is concerned about the capital gains taxes that would be due upon sale. The apartment building is located next door to her alma mater, which has expressed an interest in purchasing the apartments for much-needed dormitory space. However, the university does not have the funds to purchase the building for $500,000 in cash. Her ultimate desire would be for the university to have the property, but, based upon her financial situation, she is not able to gift the property to the university. If she could somehow make a gift to her university and still receive $500,000 from the property, she would be very happy.
Question:
Is there a method whereby she could transfer the apartment building to her alma mater and also fulfill her financial needs and objectives?
Solution:
Upon meeting with the Major Gifts Director of the university, Lynne learned that she could, in fact, transfer the property to the university, receive a nice income stream for a term of years and avoid the capital gains taxes on the sale of the property. She could accomplish this as follows.
Lynne would transfer the property to the university's foundation, as trustee of a charitable remainder annuity trust, that would pay income to Lynne for a period of 10 years. At the end of the 10 years, the trust assets would be distributed to the university. The payout rate on this trust would be 10%, which would pay her $50,000 per year for the 10 year term. Since the university would like to utilize the apartments immediately for dormitory space, the property would be sold from the trust to the university for $500,000 payable as follows: Nothing down with a 10% interest-only note payable at the rate of $50,000 per year. In order to provide security for the payments, the note would be secured by the property. Therefore, each year, on an annual basis, the university would make its $50,000 note payment to the trust and the payment would in turn be made by the trust to Lynne. At the end of 10 years, since the trust assets (a note due to the trust by the university) would be transferred to the university, the note would then be "forgiven" and the university would own the property outright.
The results of this transaction are quite beneficial. Lynne ultimately receives her $500,000 over the 10-year term. The $50,000 distribution each year is ordinary income and subject to tax. However, she does avoid the capital gains taxes and receives a tax deduction of $158,360. Based on her tax bracket, this could result in tax savings of over $50,000. The university is very happy to have solved its need for needed dorm space. Even though a payment of $50,000 is due for 10 years, the university is quite capable of making the payment because of the added rents from students. Also, the university never has to pay any principal on the note! A nice situation indeed!
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