Charitable Remainder Trusts

[BearlyWorking]

I have been doing some research on trusts and I stumbled across Charitable Remainder Trusts. There are several kinds including a fixed immediate annuity and a variable annuity type. The appealing part is that you can donate highly appreciated assets without paying capital gains and recovered depreciation, get a return of 4.5% to 6% return for life and donate the remainder to charity. It also gives a hefty charitable deduction to present taxes. It seems like a perfect way to convert highly appreciated real estate into a higher payout that can be done through rental. Am I missing anything?

Bear

 

[WhodaThunkit]

Am I missing anything?

Bear

Inflation protection offered by real estate?

 

[BearlyWorking]

I am not sure that the inflated real estate of SoCal will offer much inflation protection for the next decade or so. The 'experts' also do not see much price increase (if any) prospect in the near future in my area.

 

[wabmester]

You still pay the cap gains -- it's just deferred.    As the income beneficiary, you'll pay taxes on the distributions.

It's a great tool if you really want to donate a chunk to charity, otherwise you're probably better off taking the gains now and reinvesting for income.   Watch out for fairly expensive legal fees to create the trust, and expensive trustee fees.    You can be your own trustee, and the charity may be willing to act as trustee as well.

 

[BearlyWorking]

You still pay the cap gains -- it's just deferred. As the income beneficiary, you'll pay taxes on the distributions.

It's a great tool if you really want to donate a chunk to charity, otherwise you're probably better off taking the gains now and reinvesting for income. Watch out for fairly expensive legal fees to create the trust, and expensive trustee fees. You can be your own trustee, and the charity may be willing to act as trustee as well.

Wab -
I thought that there will not be cap gains on the sale because the charity is selling the asset. Maybe I misread. Certainly I would pay taxes on the distribution, but wouldn't that be the case if I invested it and withdrew gains?

Bear

 

[MasterBlaster]

The deduction that you can take is proportional to the expected value of the asset(s) assuming a growth rate of the asset(s) and after all of the CRT payments to you. This deduction value is usually less than the value of the asset depending on how much you take out each year.

Here's a link to the CRT calculator for Tulane University

https://www.pgcalc.com/giftcalcs/Guest/Calculator.aspx

I plugged in some numbers for a $1M gift, a $60k annual CRT annuity payout to a 50 year old, and got a tax deduction of $136k

 

[wabmester]

I thought that there will not be cap gains on the sale because the charity is selling the asset.  Maybe I misread.  Certainly I would pay taxes on the distribution, but wouldn't that be the case if I invested it and withdrew gains?

The original asset gets sold within the trust, and as you take distributions, your distribution is taxed as a cap gain (until you exhaust the cap gain character of the original asset).  Once you exhaust the original cap gain character, then you start getting taxed at whatever character the reinvested trust assets have.

If you sold the asset yourself and stuck the proceeds under your mattress, you'd take all of the cap gains hit up-front, but you wouldn't be taxed any further on the "distributions" you made to yourself.    Obviously, if you reinvest and generate additional cap gains or interest, then you'd be taxed on the new gains too.

The bottom line is that it's not a great tax shelter, and it's probably not going to net out in your favor from an income perspective either, but it is a good way to get current income and get an immediate charitable deduction if you plan to give a chunk  to some charity down the road.

 

[BearlyWorking]

I think I will understand this better with a simple example. Lets say I have real estate with a basis of 50k that is presently worth 550k. After selling expenses it results in a net of 500k. Let’s assume that any invested money will get a steady 8% per year in interest over 35 years.

If I sell and pay cap gains, state taxes and recovered depreciation, then I will end up with about 375k. If I invest this and take a 5% distribution then I will get a net of about 18.5k the first year that increases to about 50k after 35 years. Very little is cap gains in early years, but increases latter on.

If I do a CRUT then I can take a 6% distribution on 500k, which is mostly cap gains. I end up with a net of about 26.5k per year that increases to 53k over time (ignoring the charitable deduction part).

After 35 years I will have received 1.37m from CRUT, but only 1.1m from the direct sale and re-investment. The difference is that at the end of 35 years I will have 1m in asset if I directly invest, while the charity will have 1m if I do a CRT. But since I am dead the million is worthless to me, and I am happy to help someone else’s life.

Did I get this right?

Bear

 

[wabmester]

After 35 years I will have received 1.37m from CRUT, but only 1.1m from the direct sale and re-investment.  The difference is that at the end of 35 years I will have 1m in asset if I directly invest, while the charity will have 1m if I do a CRT.  But since I am dead the million is worthless to me, and I am happy to help someone else’s life.

Yes, that's basically right. As long as you plan to give that a chunk away to charity, then it makes a ton of sense for you. In the case of the CRT, the IRS wants to ensure that at least 10% of the amount is left to charity. In the non-CRT case, you're obviously free to withdraw until you hit zero. So, in essence, you are getting a tax deferral and immediate charitable deduction in exchange for an irrevocable promise to leave a chunk to charity at the end of the CRT's term.

 

[Arif]

If you're talking about real estate assets then I would also look into TICs (tenant in commons). Basically, you do a 1031 exchange and put the proceeds into a pool to purchase a large commercial property with tenants like Home Depot, CVS, etc. You get the depreciation write off so a portion of your income is shielded from immediate taxes and they pay between 6-8% payable each month or per quarter. Upon your death your portion of the asset goes to your heirs and they get a stepped up basis as well. The asset also increases in value like other real estate. I'm still looking into this as an option for our real estate holdings in the next year or so.

 

[MasterBlaster]

Arif:

I have looked into the TIC thing as well. My concern is that the people setting up the TIC and the property management take much of the profits.

How do you find a reputable TIC investment where your interests are put first ?

 

[Arif]

I have looked into the TIC thing as well. My concern is that the people setting up the TIC and the property management take much of the profits

That is how the game is set up. I am in the process of doing the same thing but on the managing side. I find the deal and structure it, finance it and the investors put up the money. We split the appreciation and the rents.
Once I am on the other side (passive investor) as long as I get my 6-7% per year I am fine with them taking their cut as long as they are running the TIC properly.

How do you find a reputable TIC investment where your interests are put first ?

I am still researching the "reputable" part of my due diligence. There has been an explosive growth in the popularity of TICs. With that kind of growth I suspect there are a lot of crooks out there as well. While I don't have an answer for finding a company you can trust I would use the same criteria I use for finding anyone (Property manager, CPA, lawyer, etc.) else to deal with my assets.
How long have they been in business, the past returns of other TICs they have set up, is the managing company also part owner of the TIC (meaning they got some skin in the game)? And just when you think you got all the right answers here are a few more concerns to ponder before you do a TIC. Go to http://www.for1031.com/facts1031.aspx?ct=11 and click on the FAQs Adobe file at the bottom of the page.

I am still a year or two away from going into a TIC but I think my strategy will be to spread the money around into different TICs and hopefully spread the risk around as well. Maybe spreading the money around between shopping centers, parking structures (my favorite), business complex, etc.

My goal is to do a 1031 into a TIC with about $1M and generate $60-70k per year in income. I am starting to build our ROTH portfolio which will provide additional income once we turn 55 or sooner if needed. In the meantime, we'll be semi retired and fund our ROTH 401k.

 

[BearlyWorking]

Wab - My thinking is that one of the implications of SWR is that you would never draw a fund down to zero on purpose. Thus, the residual asset amount ultimately only benefits those that inherit it. Just having the money gives some psychological security, but I have other pots of money for that. Doing good is not bad either.

Arif - Good suggestion about the TIC. I did a little reading at the site you gave. Commercial real estate is a new world for me. I will have to do alot of research before I can even intelligently evaluate the mechanics and pitfalls of TIC's. Oh well, just more late nights.

 

[Arif]

For those that would like to estimate their tax bill upon selling real estate that they did not reside in the last 2 years, check out this calculator:
http://www.for1031.com/cgcalc.aspx?ct=26

Makes the case for a 1031 a no brainer!