Thursday April 25, 2024
|
|
|
|
|
5.1.3 Unitrust Debt Solutions
|
Unitrust Debt Solutions
Pay the Debt Off: The simplest solution is for the donor to pay the debt off.
Debt Release: The second strategy is to obtain a release.
Bridge Loan: The third option is a bridge loan.
Partial Sale to Charity: A fourth strategy is for the charity to buy part of the property.
Personal Guarantee: The fifth strategy is for the donor to issue a personal guarantee that the debt will be paid out of retained assets.
|
According to the Federal Reserve, approximately half of all property is real estate. Donors who have real estate will also frequently have debt on the real estate. Since in most cases the debt-encumbered real estate may not be transferred into a charitable unitrust, it is appropriate to consider the strategies for removal of the debt. After the debt has been removed, the unencumbered property may then be deeded into the charitable remainder trust.
There are five strategies for removing debt from properties. These are to pay it off, to obtain a release, to use a bridge loan to pay the debt, a partial purchase of assets by the charity or a personal guarantee.
Pay the Debt Off
The simplest solution is for the donor to pay the debt off. The debt may be quite small in proportion to the value of the property and the donor may have sufficient liquid assets to make payment of the debt. If the debt is paid off, then the property may be transferred into the unitrust after the release from the lender has been recorded at the county registrar of deeds.
Example 5.1.3A
Mary Wilson has property with fair market value of $200,000, cost basis of $50,000 and debt of $10,000. She has owned the property for nearly 20 years and has continued to make payments on the debt. Since Mary has substantial other assets, she is able to pay off the debt. After the release from the lender has been recorded, the property may then be transferred into a unitrust. Since this is real property, Mary and her attorney choose to use a FLIP unitrust.
Debt Release
The second strategy is to obtain a release. Many properties has been held for a number of years, and the debt is a fairly small percentage of total value. Since most lenders are willing to allow debt to equal 80% of property value, it may be possible to obtain a release.
For example, with a large parcel of real property, a quarter section, half section or larger portion of the property may be released from the debt, allowing the balance of the property to secure the indebtedness. Alternatively, there may be multiple apartments or commercial buildings that are subject to the same debt obligation. One or more could be released and the remaining properties would secure the debt.
Example 5.1.3B
John and Mary Smith have three buildings. The buildings each have a cost basis of $200,000 and fair market value of $1 million. There is a total of $600,000 in debt on the three buildings.
Since the debt is fairly small in comparison to value of the buildings, John and Mary approach Cooperative Lender. Cooperative Lender is willing to release Buildings A and B and allow the $600,000 in debt to be secured by the value of Building C. After the release from Cooperative Lender has been recorded, John and Mary transfer Buildings A and B into a FLIP unitrust. They then sell all three buildings. The $1 million cash received from Building C is more than sufficient to pay the $600,000 debt. John and Mary receive income from the $2 million in the unitrust that was funded with Buildings A and B. The charitable income tax deduction on the FLIP unitrust also offsets tax payable on the sale of Building C.
Bridge Loan
The third option is a bridge loan. If the donor owns other real estate, then it is possible to obtain a loan on other property. The loan proceeds may then be used to pay off the debt on the property to be transferred to the unitrust. After the debt has been paid and the release recorded, the unencumbered property may then be transferred into the unitrust.
In some cases, the charity has made the bridge loan to the donor. This is permissible, so long as the terms are commercially reasonable. That is, the loan bears a reasonable rate of interest and the real estate securing the debt is sufficient in value that it could be sold to pay the debt.
Example 5.1.3C
John and Mary Wilson own three apartment buildings. Each apartment building has a value of $1 million, cost basis of $200,000 and debt of $200,000. They also own land parcel XYZ, with value of $1 million. John and Mary borrow $600,000 on parcel XYZ and pay off Buildings A, B and C. They then transfer Building A and Building B into a FLIP unitrust. John, Mary and the trustee sell Buildings A, B and C. With the $1 million cash received from Building C, they repay the bridge loan and parcel XYZ is again free and clear of debt.
Partial Sale to Charity
A fourth strategy is for the charity to buy part of the property. If there are divisible units, such as a large farm or ranch or multiple apartment buildings or commercial buildings, then it is preferable for the charity to purchase an identified property. However, in some circumstances, the charity may also purchase an undivided interest in a specific property.
Normally, the chief financial officer of the charity will be reluctant to purchase real estate as an endowment investment. However, if a portion of the value is a gift to the charity and the balance is a purchase, then the transaction frequently may be accomplished. That is, if the donor will give 10% or 15% of the property outright to the charity, the charity will then purchase the other 85% or 90%. This purchase transaction is usually acceptable. The value of the outright gift reduces the potential market risk and defrays the sales cost for the charity.
Example 5.1.3D
John and Mary Smith have apartment buildings A, B and C. Each building has a fair market value of $1 million, cost basis of $200,000 and debt of $200,000. Charity LNMO is interested in creating a unitrust with LNMO as trustee and remainder recipient. John and Mary transfer an undivided 10% of Building C as a gift to charity and also sell 90% of Building C to charity for $900,000. After paying the $200,000 debt obligation on Building C, $400,000 of the remaining $700,000 is used to pay the indebtedness on Buildings A and B. After the release has been recorded, Buildings A and B are transferred into a FLIP unitrust with the charity as trustee. The charity then sells all three properties. When the charity has received proceeds at closing, the charitable trust receives $2 million and the charity receives $1 million for selling its interest in Building C. Charity is now the remainder recipient in a CRT and also received a current gift.
Personal Guarantee
The fifth strategy is for the donor to issue a personal guarantee that the debt will be paid out of retained assets. This strategy has not been formally approved by Treasury, but has been used by individuals and advisors who are willing to undertake modest risk.
If the donor owns a substantial asset with moderate debt, it is possible to transfer an undivided percentage of that asset into a charitable trust and to retain the balance of the asset. Upon sale of the property, the donor has issued a personal guarantee that the debt will be satisfied out of the portion retained by the donor.
This plan works acceptably if the property may be sold within a reasonable period of time. After the sale, the trust receives its portion and the donor pays the debt from his or her portion of the retained asset. Once the debt has been paid and the trust has received its full value, the transaction is unlikely to be questioned by the IRS. If the property is readily saleable, this personal guarantee strategy can be contemplated.
Example 5.1.3E
John and Mary Smith own an apartment building with value of $1 million and the cost basis of $100,000. They have taken straight-line depreciation and would have no ordinary income recapture if the property were sold. There is debt on the property of $200,000.
John and Mary visit with their attorney and decide to fund a FLIP unitrust with an undivided 60% interest in the property. They determine that they will retain an undivided 40%. With their 40% interest, they will be able to fulfill their personal guarantee to pay the full $200,000 debt at closing. In order to minimize any risk that there would be problems with prearranged sale or potential indirect self-dealing, the attorney serves as the initial trustee of the FLIP unitrust and also receives title to the 40% held for John and Mary in a revocable trust.
The unitrust is funded and John and Mary issue a personal guarantee that the $200,000 in debt will be paid from the balance of the property. The attorney as trustee then lists the property for sale and sells in approximately two months. At closing, the $200,000 debt is paid from the $400,000 share of John and Mary. John and Mary benefit from the 6% unitrust funded with $600,000. They bypass $540,000 of gain on that trust and receive an income tax deduction of $252,372. The trust will pay an estimated $745,071 over their projected 18.4 years of life expectancy. After two lives, the charity will receive $765,313.
Since cash was received, there will be a gain of $360,000. In addition, they will pay $200,000 to cover the debt. After paying the debt, the charitable deduction offsets the tax payable on the portion sold and John and Mary have $200,000 cash plus income for two lives from the $600,000 unitrust.
|
Case Studies on Unitrust Debt Solutions
Exit Strategies for Real Estate Investors, Part 4:
Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. By far, Karl was most successful with real estate investments. It was definitely his passion.
Exit Strategies for Real Estate Investors, Part 5:
Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. Karl's passion was real estate, and he was very successful in his investments.
Unitrust Debt Solution:
Several years ago Mother and Father built a very unique home on 45 acres of beautiful rolling hills and woods. Father passed away three years ago, and Mother now solely owns the 45-acre parcel and home.
Paying off a Mortgage Using a CRT:
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.
|
|
|
|
|
|
|
|
|
|
|
© Copyright 1999-2024 Crescendo Interactive, Inc.
|
|
