can be very profitable in Real Life
...If you know how.
Jim Wilson, CCIM
Unfortunately, I have seen a great many people instantaneously
close their minds and stop listening to anything said
when the word "charity" is mentioned. The
problem is that a Charitable Remainder Trust (CRT) would
be the most ideal strategy for preserving their wealth
for a large percentage of these people. When using a
CRT strategy, nothing goes to charity until all the
asset owners have died and the heirs have received the
whole value of the assets tax-free. The fact is, until
all owners die, all the benefits of ownership remain
with the owner of the assets. A companion Wealth Replacement
Trust is used to pass the entire value of the assets
on to the heirs in cash tax and probate free. So, lets
explore how this all works in the real world.
I have found that it is possible to overcome the emotional
barrier to considering this great investment strategy
is to ELIMINATE THE USE OF THE WORD "CHARITABLE."
Think of a CRT as a "SELF-DIRECTED TAX-EXEMPT TRUST."
There are some limitations on ownership benefits with
this trust as there are with many other forms of asset
ownership. This will help to reopen the thought process
and clear the vision. Assets are owned to produce benefits
such as regular cash flow income, capital wealth accumulation,
personal use, pride-of- ownership, emotional security,
and financial security for family members after death.
The various forms of trusts, partnerships, and corporations
are just tools and strategies when one thinks of their
assets in terms of BENEFITS. Millions of people own
assets in regular "C" corporations. This form
of ownership has many benefits but also subjects the
owner to double taxation, limitations on tax deductions,
and many other negative ownership aspects. Under some
circumstances, the "C" corporation is absolutely
perfect to achieve certain benefits. The "C"
corporation does not fit all circumstances nor do any
of the other legal forms under which title can be held.
A CRT is no different. It all depends upon the benefits
the owner is seeking under their specific circumstances.
Jim Wilson, CCIM, EMS is a Candidate
for Membership in the Society of Exchange Counselors.
He is President of Investment & Real Estate Solutions,
Inc. in Orlando, Florida, and Real Estate Director and
Board Member of the Children's Community Foundation.
Has been in the real estate and financing
fields for 32 years. His experience includes development
and construction of residential, commercial and industrial
projects and extensive experience in tax-deferred exchanging
and utilization of charitable trusts with real estate
investment assets. Jim previously held a Certified Business
Counselor's designation and was an instructor for the
Institute of Certified Business Counselors and has conducted
real estate related training seminars and workshops
nationally for over 25 years. Jim is a real estate investor
and is currently managing partner in several active
real estate development projects.
Twenty-five years ago, George and Helen took some classes
and read some books and became very adept at buying rental
houses and two-family rental properties with NOTHING DOWN.
Over the years, they have accumulated ownership of 20 such
properties. They have renovated, managed, leased, maintained
and improved their properties. The lovely, wonderful tenants
have paid off virtually all of the mortgages for them and
they now have a substantial monthly income from these properties.
George and Helen's circumstances have changed greatly in
25 years. Their children are all grown, through college and
on their own. The grandchildren are spread over several different
states. They have depreciated all of their rental properties
down to the land value and they have no interest deductions.
Virtually all of their rental income is being taxed at ordinary
income rates for both Federal and state taxes. They are good
managers and do not have a lot of after-hours emergencies.
However, they still must be there to MANAGE. They also have
to replace roofs, refrigerators, air conditioners, etc. at
regular intervals. They must see to cleaning and maintenance
between tenants and handle leasing. All the accounting and
record keeping has become much more of a chore in the last
few years. They are now in their 60's and have become more
interested in getting in the motor home to go see the grandchildren
and taking a cruise a couple of time a year with their family
and friends. They have not had good experiences with professional
property managers when they have tried them. The good news
is that they now own approximately $4,500,000 in nearly free
and clear income-producing rental property. The bad news is
that their basis for tax purposes is only about $300,000.
In addition, their income from the property is so great that
they are now in the very highest income tax bracket. To add
insult to injury, they do not need anything close to the amount
of income on which they are paying taxes to live in the style
they want. After doing some financial planning, they have
discovered that if they were to die, the estate taxes in 2004
would be at 50% of all their assets in excess of $1,500,000.
There are strategies using living trusts that can be used
to double the amount of the estate tax exemption but they
would eventually have to deal with estate taxes when both
spouses have passed away. There are a number of estate planning
strategies that can be used to eliminate tax problem upon
death and a IRS Section 1031 exchange could be used to convert
the ownership of 20 small residential rental properties to
a larger low or no management income-producing property without
the current CAPITAL GAIN taxes. Unfortunately, the 1031 exchange
will NOT eliminate the estate tax problem.
This situation is ideal to employ a SELF-DIRECTED TAX-EXEMPT
TRUST with a companion WEALTH REPLACEMENT TRUST to pass on
the entire value of their assets tax-free and in cash to their
children and grandchildren WITHOUT even the problems and costs
of probate. The simple approach is to establish the George
and Helen tax-exempt trust with George and Helen the directing
beneficiaries. The wealth replacement trust is established
with their children and grandchildren as the beneficiaries.
The titles to the rental properties are transferred from George
and Helen to the George and Helen Trust. The trust sells the
property tax-exempt and all the proceeds after costs of sale
are then reinvested at George and Helen's direction into their
choice of more passive investment. These investments could
be no-management net leased properties, mortgages, partnership
shares in larger high quality income properties, or any of
the traditional types of securities such as stock, bonds,
mutual funds, etc. They might choose to spread their reinvestment
cash out over several of these investment alternatives to
provide income security as long as they live. The income they
take out of their trust will be taxable but they do not have
to take out more income than they need to live in the lifestyle
they choose. If they have income inside of their trust greater
than their personal needs, they can simply direct the reinvested
inside the trust TAX-EXEMPT.
BIG BENEFIT!!! If they were to sell their property for $4.5
million with a current adjusted basis of $300,000 they would
owe Federal capital gains taxes of a minimum of $600,000 allowing
for sales costs. If they are subject to depreciation recapture,
their tax bill will be larger. If they live in a state that
also taxes capital gains, their tax bill will be even greater.
By using a self-directed tax-exempt trust, George and Helen
will be able to keep and reinvest the $600,000. Even at 5%
return, that would provide $30,000 per year ADDITIONAL income
for as long as either George or Helen is alive. Since they
are only in their 60's, they will most probably live at least
another 20 years. That means they would get all $600,000 to
use during their life and then they can pass the $600,000
along with the rest of their assets on to their heirs tax-free
The Wealth Replacement Trust is the vehicle use to pass on
the total value of the assets to the heirs. There are a variety
of structures to accomplish this but the most used is method
is an Irrevocable Life Insurance Trust. A small amount of
the income paid out of the George and Helen Tax-Exempt Trust
is used, in compliance with the IRS rules, to purchase a specialized
insurance program to fund the life insurance trust. Unless
the dollar amount of assets is extremely large (over $10 million)
the cost of the life insurance can be structured to have very
little impact on the growth of the assets in the tax-exempt
trust. There are a variety of methods to deal with a high-dollar
asset situation, which I will not go into here. There are
two important benefits to using a life insurance trust as
proposed. (1) The life insurance trust can be used and structured
exactly as one would a will WITHOUT the problems of probating
a will. (2) The assets are passed on to the heirs tax-free
in cash. 100% of estate taxes are eliminated and one does
not have to schedule dying in 2010 to accomplish this objective.
The Wealth Replacement Trust can even be indexed for inflation.
Only after George and Helen have passed away is there a gift
to charity of whatever assets that are left in the tax-exempt
trust. George and Helen get to choose which charities are
to receive this residual benefit. They can change their choice
at any time while they are alive. They can choose more than
one charity as long as it is a qualifying charity, which may
include their church. In this case, George and Helen decided
to have their tax-exempt trust convert to the George and Helen
Family Foundation when they have both passed away. Their family
foundation will distribute the income from the assets to the
charities of their choice as long as the foundation has any
assets. Their children will participate in future decisions
concerning which charities are to receive the annual gifts,
which can provide many social and prestige benefits to the
children and grandchildren for generations.
BONUS BENEFIT!!!! Since there is eventually a gift to the
charity or charities of the choice of George and Helen, they
will receive a current tax deduction for the present value
of that future gift. The amount of the current tax deduction
will depend upon the ages of George and Helen, the amount
of income they will take out of THEIR trust each year, a government
funds rate, etc. There is a formula proscribed by IRS to calculate
the deduction. To put it into simple terms, the current tax
deduction will range somewhere between 10% and 40% of the
value of the assets placed into their tax-exempt trust.
Obviously, any use of tax-exempt trust or any other tax reduction
and estate planning strategy needs to be accomplished with
the guidance of qualified and experienced tax, legal and financial
planning professional. The example presented here is only
one relatively simple application of the SELF-DIRECTED TAX-EXEMPT
TRUST strategy. In the next issue, we will explore how to
use a self-directed tax-exempt trust to accomplish the disposition
of a property with multiple owners who have widely divergent
financial and lifestyle objectives.