InKnowVision HNW Technical Webinar - Charitable Life Estates
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This infrequently used technique can be very powerful when working with high net worth clients. We will look at a couple examples where InKnowVision has used this structure to create significant income and estate tax savings and paired this technique with wealth replacement trusts in order to deliver full value to the family. In this presentation we will explore how to present the concept to clients and also take a look into the variables that go into the ultimate calculation. Learn more at www.inknowvision.com
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InKnowVision HNW Technical Webinar - Charitable Life Estates
- 1. Technical Webinar ยฉ2012. InKnowVision LLC. All rights reserved. www.inknowvision.com ยฉ 2012 InKnowVision, LLC
- 2. InKnowVision www.inknowvision.com Upcoming Webcasts: ๏ Marketing Webinar ๏ก March 28th ๏ Case Study ๏ก April 4th ๏ Next Technical Webinar: Captive Insurance Company Planning ๏ก April 18th
- 3. Charitable Life Estates INKNOWVISION, LLC SCOTT HAMILTON, JD, CEO MARCH 21, 2012 WWW.INKNOWVISION.COM 630-596-5090 ยฉ 2012 InKnowVision, LLC
- 4. Case Study ๏ 77 and 74 year old ๏ House worth 4.5M ๏ Deduction-$4M+ ๏ Tax Savings-$1.8M ยฉ 2012 InKnowVision, LLC
- 5. Why Do a Charitable Life Estate ๏ Income tax deduction for client ๏ No change in lifestyle ๏ Satisfy charitable giving intent ยฉ 2012 InKnowVision, LLC
- 6. When would you use it? ๏ Owner does not care about keeping home in family ๏ Can benefit from current income tax deduction ๏ Has some charitable intent ๏ Can replace some or all of the gift with life insurance ยฉ 2012 InKnowVision, LLC
- 7. When would you not use it? ๏ Owner cares about keeping home in family ๏ Cannot benefit from current income tax deduction ๏ Has no charitable intent ๏ Cannot replace some or all of the gift with life insurance ยฉ 2012 InKnowVision, LLC
- 8. What Type of Property Qualifies? ๏ Any property used by the taxpayer as a personal residence even though it is not used as the principal residence. ๏ก Single family homes ๏ก Condos ๏ก Co-ops ยฉ 2012 InKnowVision, LLC
- 9. What Type of Property Qualifies? ๏ QPRT definition may apply to include ๏ก mobile home ๏ก Boat ๏ก house trailer if ๏ก contains sleeping space, toilet, and cooking facilities ยฉ 2012 InKnowVision, LLC
- 10. Farms ๏ Farm means any land used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock. ๏ Includes improvements like barns, house, etc ๏ Not limited to house and reasonable land like a QPRT ยฉ 2012 InKnowVision, LLC
- 11. Can cost of furnishings be deducted? ๏ No ยฉ 2012 InKnowVision, LLC
- 12. Is rental property OK? ๏ Yes ๏ Ltr. Rul. 8711038 ยฉ 2012 InKnowVision, LLC
- 13. How do you do it? ๏ Deed - Irrevocable transfer of property to charity ๏ Reservation of life estate ยฉ 2012 InKnowVision, LLC
- 14. Agreement ๏ Life Tenants ๏ก Who are they? ๏ก Are their more than one? ๏ก Is there a line of succession? ๏ Term of Year ๏ก Who are tenants? ๏ก Successor tenants ยฉ 2012 InKnowVision, LLC
- 15. Other Agreement Terms ๏ Who maintains the premises ๏ Who insures the property against loss and liability ๏ Who repairs the premises in the event of damage ๏ Prohibition on additional liens or encumbrances ยฉ 2012 InKnowVision, LLC
- 16. Agreement Terms ๏ What if life tenant wants to sublet ๏ Vacate ๏ Sell with or without repurchase ๏ Access for periodic inspection ยฉ 2012 InKnowVision, LLC
- 17. Additional Items ๏ Obtain clear title ๏ Environmental concerns ๏ Property tax valuation and transfer tax expense ยฉ 2012 InKnowVision, LLC
- 18. The Deduction ๏ The donor is entitled to a charitable contribution income tax deduction in an amount equal to the net present value of the charitable remainder interest. ยฉ 2012 InKnowVision, LLC
- 19. Deduction Calculation Elements ๏ FMVof the property ๏ FMV of depreciable property ๏ Estimated useful life of the depreciable property ๏ Salvage value of the depreciable improvements ๏ Measuring term of the agreement and ๏ AFR ยฉ 2012 InKnowVision, LLC
- 20. FMV of Property ๏ If over $5,000, must have a qualified appraisal ๏ FMV reduced by any indebtedness ยฉ 2012 InKnowVision, LLC
- 21. Depreciable Property ๏ If any part of the real property is subject to exhaustion, wear and tear, or obsolescence, a special factor is used in valuing the remainder interest in that part ๏ Depreciation computed using straight-line over the asset's useful life ยฉ 2012 InKnowVision, LLC
- 22. Estimated Useful Life ๏ How long will the depreciable part of property be useful for its intended purpose? ๏ OK to use depreciation schedule for similar property ๏ก 27.5 years for residential property ยฉ 2012 InKnowVision, LLC
- 23. Salvage Value ๏ What will the depreciable property be worth at the end of the useful life? ยฉ 2012 InKnowVision, LLC
- 24. What is the Term? ๏ Term of years or measuring life? ๏ Terminal illness (7520) ยฉ 2012 InKnowVision, LLC
- 25. Calculator ยฉ 2012 InKnowVision, LLC
- 26. I want to leave-what are my options? ๏ Rent ๏ Sell ๏ Gift ยฉ 2012 InKnowVision, LLC
- 27. Options ๏ Rent the property ๏ Income comes to life tenant ยฉ 2012 InKnowVision, LLC
- 28. Options ๏ Sell the property ๏ก Replace the property sold ๏ท Buy new property subject to life estate ๏ก No replacement ๏ท Divide proceeds ยฉ 2012 InKnowVision, LLC
- 29. Options ๏ Accelerate the gift ยฉ 2012 InKnowVision, LLC
- 30. What about capital improvements? ๏ Treated as an additional contribution ๏ Additional tax deduction ยฉ 2012 InKnowVision, LLC
- 31. Bargain Sale of Remainder Interest ๏ Part gift/sale of remainder interest ๏ Charity pays cash ๏ Reduces tax deduction ๏ May cause gain to be recognized ยฉ 2012 InKnowVision, LLC
- 32. Debt Encumbered Property ๏ If the transferred property is subject to indebtedness, however, the transaction is subject to the bargain sale rules. ๏ When debt encumbered property is transferred to charity by outright gift, the entire amount of the indebtedness is considered an amount realized by the donor. ยฉ 2012 InKnowVision, LLC
- 33. Application of $250,000 Capital Gain Exclusion ๏ Yes ยฉ 2012 InKnowVision, LLC
- 34. Gift Tax Return ๏ Yes ยฉ 2012 InKnowVision, LLC
- 35. InKnowVision โ Next Steps ๏ Set up a call to discuss our process 630-596-5090 ๏ Check out our website www.inknowvision.com ๏ Join our newsletter list ๏ Join our LinkedIn group ๏ Call us about a case ยฉ 2012 InKnowVision, LLC
Editor's Notes
- Because the amount claimed as a charitable contribution deduction most often exceeds $5,000.00, the fair market value of property must be established by a qualified independent appraisal. For purposes of the computation, the fair market value is reduced by any indebtedness secured by the property.
- If any part of the real property is subject to exhaustion, wear and tear, or obsolescence, a special factor is used in valuing the remainder interest in that part. Further, if any part of the property is subject to depletion of its natural resources, such depletion is taken into account in establishing the present value of the remainder interest. Depreciation and depletion are computed using the straight-line method over the asset's useful life
- The term "estimated useful life" means the estimated period (beginning on the date of contribution) over which the property may reasonably be expected to be useful for its expected use. The estimated useful life is not limited to the measuring term of the life estate or term of years preceding the remainder interest; rather, consideration is to be given to the provisions of the governing instrument or applicable local law, if any, relating to the use, preservation, and maintenance of the property. For this purpose, the estimates of engineers or other persons skilled in estimating the useful life of similar property may be used. As an alternative, the taxpayer can use a depreciable schedule for similar property class pursuant to Reg. ยง1.167(a)-11(b)(4) in effect on the date of transfer.
- Life estate agreements are most frequently measured by the lifetime of one or more individuals; however, the agreement can also be measured by a term of years or by the longer of the life or lives of individuals and a term of years. If the agreement is measured by one or more lives, the individuals must be in being at the time the agreement is created. If the agreement is measured by a fixed term of years, there is no minimum or maximum term for federal tax purposes; however, state law may impose limitations.ย It should be noted that if an individual who is a measuring life is terminally ill at the time of the transaction, the mortality component prescribed under IRC ยง7520 need not be used to determine the present value of the remainder interest. For this purpose, an individual who is known to have an incurable illness or other deteriorating physical condition is considered terminally ill if there is at least a 50 percent probability that the individual will die within one year. However, if the individual survives for eighteen months or longer after the date of the transaction, that individual shall be presumed to have not been terminally ill at the time of the transaction unless the contrary is established by clear and convincing evidence.
- The life tenant retains all beneficial lifetime rights in the property. This includes the ability to rent the property and receive the income therefrom. The gift agreement should contemplate this possibility and establish responsibilities for property management and maintenance should the life tenant vacate the property.
- Another option available to donor and charity is to sell the property and divide the net sales proceeds according to each party's interest at the time of sale. For this purpose, a present value of the remainder interest is calculated using the net sales proceeds and the date of sale. Any expenses, such as outstanding property taxes that would otherwise be attributable to the life tenant are deducted from the life tenant's share prior to distribution. The present value of the remainder interest is then distributed to charity with the remaining proceeds distributed to the donor. The donor will realize gain based on their proportionate share of the sales proceeds.It should be noted that the gift agreement cannot compel the charity to sell its interest prior to the expiration of the measuring term stated in the gift agreement; to do so, according to Rev. Rul. 77-305, could defeat the charity's remainder interest in the residence itself.21ย The decision to sell must, therefore, be voluntary on the part of both parties and not subject to a condition subsequent in the gift agreement
- Yet a third option involves the donor contributing the balance of the life estate thereby accelerating the gift of the remainder interest. In such cases, the donor is entitled to receive an additional charitable contribution income tax deduction based on the present value of their remaining life or term of years estate. For this purpose, the present value of the remainder interest is calculated using the fair market value of the property on the date the retained life or term of years estate is transferred. The present value of the remainder interest is subtracted from the fair market value of the property to produce the present value of the remaining life or term of years estate. This amount qualifies for charitable contribution deduction purposes.
- In many cases an individual's personal residence or farm represents a major component of their estate. Likewise, ideal candidates for life estate agreements are retired, may have modest income, and may be in need of or desire supplemental income.ย In a traditional life estate agreement, the donor contributes the entire remainder interest in the property to charity. However, the donor is not required to do so. As an alternative, a prospective donor can offer to sell a portion of the remainder interest in conjunction with a contribution of the remaining portion. In such cases, the charity may offer payment in the form of cash, an installment note, or a charitable gift annuity (if available). In essence, the concept represents a sophisticated form of bargain sale.Because the purchasing charitable organization must make payment from sources exclusive from the contributed remainder interest, acceptable candidates for this technique are generally older and have property that is debt-free or significantly debt-free.
- Any person making a gift of a remainder interest in a personal residence or farm in any amount should file a federal gift tax return (Form 709) for the year in which the gift is made, even if no gift tax is due. The reason? Even though contributions of a remainder interest in a personal residence or farm to charity qualify for the unlimited gift tax charitable deduction under IRC ยง2522, charitable contributions of a partial interest are not one of the specific exceptions under IRC ยง6019 that relieves donors from having to file a gift tax return.