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Friday, May 3, 2024
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Case Studies |
Paying off a Mortgage Using a CRT
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Case:
John Mark and Sarah Andrews have served with a relief charity in Brazil for the past 40 years. Knowing that their charitable organization, Worldwide Relief Services, Inc. (WRS) would provide only limited funds for retirement when that time came, they began taking what money they had and investing in rental property. When they were on furlough in the late 1950s and early 1960s, they purchased three homes in the Silicon Valley of Northern California. They purchased the first home in 1958 for $25,000. Due to the market conditions in the Silicon Valley, the current value of that home is now $800,000. The other two homes have experienced similar appreciation in value.
John Mark and Sarah are now both 64 years of age and would like to retire in Northern California, about a 30-minute drive north of San Francisco in the Napa area. The purchase price of the new home is expected to be $450,000. They have $50,000 in cash, which they will use as a down payment, and would like to finance the balance on a 15-year mortgage. Assuming that they are able to obtain a loan at 7%, the monthly payments over the 15-year term will be $3,600 per month.
These are substantial payments, but they fell in love with this home and would like to explore all options to purchase their "dream home." John Mark and Sarah have no children and eventually plan to leave their entire estate to the WRS. In order to assist other retired relief workers, they desire to see their estate fund an endowment account, the primary purpose of which will be to provide retirement funds for those who have given much of their lives for helping others.
Question:
John Mark and Sarah are considering selling the home they purchased in 1958. They know that because of the "hot" Silicon Valley market, they will immediately receive multiple offers on the property. However, they don't believe it is good stewardship to pay huge capital gains taxes on the sale and send that money to Uncle Sam. They would also like to establish the "relief worker retirement endowment fund" during their lifetimes so they can see the benefits of the fund at work. What is the best option for John Mark and Sarah to accomplish these objectives?
Solution:
In discussing these matters with the Director of Major Gifts at WRS, John Mark and Sarah decided that their best option would be to use the rental home valued at $800,000 to fund a term of years charitable remainder annuity trust. The trust would be established for a 15-year term with a payout rate of 8%, so they will receive annual payments from the trust totaling $64,000. The payments on the home will be $3,600 per month, for a total of $43,200 per year. Therefore, the after-tax income from the trust will more than cover the monthly mortgage payments and the extra income can be used to pay any additional California state income taxes. However, their income taxes will be substantially reduced by sizeable mortagage interest deductions. Combining the interest deductions with the charitable deduction from the trust (described below) will provide John Mark and Sarah with a reduction in taxes for many years to come.
At the end of 15 years, the mortgage will be paid off and the trust will terminate and be distributed to WRS, to be used as John Mark and Sarah desire. If the trust earnings rate is 9% or more, over $1,000,000 will be available for the retirement fund. As they wished, John Mark and Sarah will now be able to see substantial funds utilized to support other retired relief workers.
In addition to these benefits, they will bypass the capital gains taxes (the value of which will now go to charity instead of Uncle Sam) and they will receive an income tax deduction of over $190,000. Even though they probably would not be able to use this deduction over the allowable six-year period, it will assist in reducing the income taxes due on the distributions from the trust for those first few years.
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