Charitable Remainder Trusts & Irrevocable Life Insurance Trusts

Traditionally, real estate values are cyclical in nature. As the dramatic downturn in values begins to correct itself many investors will again see real estate gains.

Locking in any gains from the real estate traditionally comes with a cost: capital gains taxes. Most investors are aware of the fact that you can defer those gains with a 1031 like/kind exchange. But all that does is trade one property for another and defer the tax. If you are concerned about property values decreasing further, trading one property for another doesn’t address your major concern of the potential drop in value.

What has been available to investors in real estate and stocks for over 40 years is a tool that allows an individual to create a trust which:

  • Names themself as Trustee;
  • Pays all income to them for life;
  • Liquidates real estate and stocks and pays no capital gains tax;
  • Obtains a current income tax deduction;
  • Upon death, makes a significant donation to the charity of their choice; and
  • Doubles or triples the amount of money that will pass to their heirs.

Consider an example:

  • Ron and Elaine own a piece of property valued at $400,000, which they bought for $100,000 (giving them a cost basis of $100,000). If they sell it, they will have $300,000 in capital gains. Federal capital gains taxes are 15% and California capital gains taxes are 9%, resulting in taxes due of $72,000. That leaves $328,000 to reinvest. If they reinvest that $328,000 at 6%, there would be $19,680 of income per year.
  • Instead, they transfer the property to a Charitable Remainder Trust. They name themselves as Co-Trustees. They names themselves as beneficiaries. The trust then sells the property. Since it is a charitable trust, it pays no capital gains taxes. The trust reinvests the entire $400,000 at 6%, increasing income to $24,000 a year, an increase of $4,320, or 22%.
  • Unlike a 1031 exchange which only defers the gain to the next sale, the sale in a Charitable Remainder Trust of a capital assets is tax-exempt.
  • Because the trust irrevocably transfers the property to Ron and Elaine’s favorite charity upon both of their deaths, they receive a charitable deduction on this year’s income tax return for the present value of the future gift to the charity. This value is a direct function of the Trustors’ age and the rate of return of the trust. Assuming Ron is 60 years old and Elaine is 58 years old, the current deduction against income taxes would be $88,232.
  • Ron and Elaine then take these tax savings (on the money that would have gone to the IRS in capital gains taxes which is now reinvested in the trust) and purchase life insurance through an Irrevocable Life Insurance Trust. The proceeds of that Irrevocable Life Insurance Trust will be paid to Ron and Elaine’s heirs upon both of their deaths, when the proceeds of the Charitable Remainder Trust are paid to the charity. Life insurance proceeds from an Irrevocable Life Insurance Trust are free from Federal estate taxes.
  • In conclusion, if Ron and Elaine utilize a Charitable Remainder Trust, the entire $400,000 in proceeds are available for reinvestment. No portion is payable to the government in the form of capital gains tax. Assuming a 6% payout, that would generate $24,000 a year of income (as opposed to $19,680 if they sell, pay the tax and reinvest the rest). The present value of the future gift to the charity can be used as an income tax deduction on this year’s income tax return, resulting in an $88,230 deduction against other earned income. Since Ron and Elaine are in the top income tax bracket, this results in the actual taxes saved of over $41,000. Upon Ron and Elaine’s death, the life insurance replaces the wealth that was transferred to Ron and Elaine’s charity in the form of a check to their heirs, which is received completely tax free.

If you are holding low basis real estate or stock and would like to lock in your gain without paying any capital gains tax, then a Charitable Remainder Trust needs your immediate attention. Not only will you pay no capital gains tax, but you will generate a significant or substantial income tax deduction on this year’s income tax return, which can be used to offset other income.

If this is something of interest to you, you need to contact Mark S. Drobny as soon as possible in order to make sure that everything is done prior to the end of the calendar year.

4180 Truxel Road, Suite 100 Sacramento, CA 95834 • Tel. 916-419-2100 • FAX 916-419-1222

Ratings and Reviews

8.3Mark Steven Drobny