Friday March 29, 2024

3.7.3 Life Estate Rollover Options

Life Estate Rollover Options

Joint Sale:   Mary Jones and the charity can enter into a joint sale.

Gift of Life Estate:   Mary could decide to give the life estate, valued at $145,870, to the charity, The charity would then own both the remainder value and the life estate and could sell the home.

Remainder Unitrust:   If Mary desires to receive income, she could contribute her life interest to a charitable remainder unitrust.

Gift Annuity:   With the home sale exclusion of up to $250,000 of long term capital gain, it may be possible to exchange the life interest in exchange for a gift annuity.

Combination Plan:   In Rev. Rul. 87-37, the IRS acquiesced in a plan that involved a gift of 1/10th of a remainder interest.

Conclusion:   Flexibility is a wonderful tool.

Under Sec. 170(f)(2) of the Internal Revenue Code, a person may give a remainder interest in a personal residence, farm or ranch to a charity and reserve the right to live there for one or two lives. But what if circumstances change and the donor no longer desires to live in the home? There are several potential flexibility options for this donor.

Example 3.7.3A Life Estate and Surviving Spouse

Assume that John and Mary Jones, both age 75, transfer the remainder interest in their $300,000 home to charity. Under the Applicable Federal Rate (AFR) at that time, they receive an income tax deduction of $109,245. In effect, they give this value to the charity and the remaining $190,755 represents the value of their life estate, the right to live in their home for two lives. However, five years later John passes away. Mary decides at that time that she would rather live in Happy Acres Retirement Community. What are her possible options? Fortunately, she is not locked into the life estate. She and the charity have several attractive potential options.

Joint Sale

Mary Jones and the charity can enter into a joint sale. The home is now owned in part by Mary Jones and in part by the charity. Just as with any other type of joint ownership, they can agree together to sell and divide the proceeds.

Based on the AFR on the date of the sale, the home worth $350,000 at that time would have a value to the charity of $204,130 and a value to Mary Jones of $145,870. These would be the respective values of the remainder interest and the life interest value at that time. They could agree jointly to sell the property and divide the proceeds accordingly. Mary Jones would have a very substantial capital gain, but could use her $250,000 capital gains tax exclusion to zero the tax.

Gift of Life Estate

Mary could decide to give the life estate, valued at $145,870, to the charity. The charity would then own both the remainder value and the life estate and could sell the home. Mary would receive an income tax deduction for the value of the life estate she had gifted.

Remainder Unitrust

If Mary desires to receive income, she could contribute her life interest to a charitable remainder unitrust. Since the life interest under state law is a valid property interest and she transfers her entire retained ownership into the trust, she should receive a deduction for a gift of appreciated property.

Alternatively, if her $250,000 exclusion is available, the gain on the $145,870 may be offset, and it may be preferable to sell for cash and then contribute the sales proceeds to the trust. This latter course results in a cash-type deduction usable to 50% of adjusted gross income. In either case, Mary can receive the income from the $145,870 for life.

Gift Annuity

With the home sale exclusion of up to $250,000 of long term capital gain, it may be possible for Mary to transfer her life interest in exchange for the gift annuity. In this circumstance, it would be important that the gift annuity based upon the value of the life interest has at least a 10% charitable interest, since that is the minimum requirement for a qualified gift annuity under Sec. 514(c)(5) of the Internal Revenue Code. If Mary is able to use the exclusion for the transfer of the life estate, as permitted by Rev. Rul. 84-43, the gift annuity would be treated as though she contributed cash and she would receive both a charitable deduction and substantial tax-free return from the annuity.

Combination Plan

In Rev. Rul. 87-37, the IRS acquiesced in a plan that involved a gift of 1/10th of a remainder interest. So long as the interest transferred was an undivided percentage of the qualified gift plan, the gift was permissible and entitled to a charitable deduction. In essence, this revenue ruling is authority for the concept of dividing the remainder and income interests and transferring undivided percentages of those interests into another plan.

For example, Mary might choose to sell 1/2 of the value of her life interest and then transfer the balance into either the unitrust or gift annuity. This flexibility enables use of combination interests and is very helpful in crafting a rollover solution that optimizes benefits and achieves Mary's goals.

Conclusion

Flexibility is a wonderful tool. Very few counselors are fully aware of opportunities for flexibility with life estate agreements. If more gift planners and counselors understood the inherent flexibility of this plan, friends of charities would create far more life estates.

One caution must be emphasized with respect to the "MIT agreement" - the charity must have a remainder interest in the home and there can be no prearranged obligation to select any of the possible flexibility options. The IRS will deny the charitable income tax deduction if any binding obligation exists. In any case, the purpose of having flexibility options is enhanced by not choosing one until the time for a later change of ownership.

Case Studies on Life Estate Rollover Options

The Flexible Life Estate:   Melvin and Mae Brooks are proud and loyal supporters of the arts. In fact, over the past two decades, they have contributed almost $500,000 to the arts in their community. Not surprisingly, the Brookses intend to leave a portion of their estate to charity. Specifically, the Brookses plan on bequeathing their $250,000 home to the local art museum. During a discussion with the art museum's staff, Tom Borman, the gift planning officer, suggested that a life estate (i.e., gift of the remainder interest in a home) may work nicely given the Brookses' objectives. He said the irrevocable transfer of the remainder interest in their home would provide an immediate charitable income tax deduction. More importantly, the Brookses could live in the house for the rest of their lives, and, upon the second death, the home would pass to charity without having to go through probate.


      Quiz-Basic



© Copyright 1999-2024 Crescendo Interactive, Inc.