Lifetime Possession : For Homes That Go to College

Universities today are increasingly wooing elderly homeowners with a long-used but rarely promoted trade-off:

A lifetime annuity in exchange for the university’s eventual ownership of the home. And in few states, plan administrators suggest, is the ground more fertile for such an approach than in California, where there are more than 1.5 million homeowners over the age of 65 sitting on housing that has exploded in value tenfold over the last 30 years.

There are various ways to address the question.

The most common arrangement for achieving this trade-off is a variation of the “gift annuity”--splitting ownership of the home into two legal entities. One would be the “life estate” or the right of the donor to retain physical possession of the home until death. The other would be the “remainder estate,” or the institution’s right to free title to the home when the donor dies.

State License Law

Under California law, for instance, this gift annuity approach requires that the charity or university be licensed through the California Department of Real Estate.

Pepperdine University and UCLA are. At USC, however, according to Geoff Gilchrist, director of the real estate division of USC’s Development Council, the same end result is achieved without going the licensing route.

“We’ve just never done the gift annuity, as such,” Gilchrist says, “not really because of the licensing requirement but because when you issue a gift annuity, what you’re doing is pledging all of the assets and resources of the university behind it. Recently, though, tax-wise, the gift annuity has become more favorable as a tool, so we may go ahead and apply for a gift annuity license.”

But, at present, “we simply purchase the remainder interest at a bargain price. Let’s say,” Gilchrist continues, “that the property is worth $100,000. We might say to the donor, ‘OK, we’ll buy the remainder interest in the house for $70,000 and we’ll give you an interest-only note at, say, 10%--that’s $7,000 a year.’

University Makes Payments

“Then we ask them to take that note and place it into a charitable remainder trust. All that happens, really, is that now the university makes payments to the trust, which then passes the interest payments on to the donor. And, when the donor dies, the university gets the note back, as well as the house.” About 20 such arrangements have been set up by Gilchrist in the past four years.

And rarely, according to Douglas Freeman, a West Los Angeles attorney specializing in charitable giving, is a tax consideration involved since the Internal Revenue Service’s one-time, $125,000 exemption from capital gains tax applies (if the seller is 55, or older) just as it would in a more conventional sale.

More popular with USC donors at the moment, however, Gilchrist adds, is an arrangement where the donor no longer wants to live in the house--”or, it doesn’t even have to be his principal residence, it’s just another piece of real estate he owns”--and so they simply give USC the property.

“We then convert the whole thing into a trust income for them. Whenever you take a piece of real estate and put it into a trust and the trust sells it, there’s no recognition of capital gains tax.

Converting Low Yield

“What we’re doing, in effect, is taking a piece of property that’s highly appreciated in value--but has a low or a zero yield--and converting it to a high yield for them without going through the trauma and expense of selling and without having it ravaged by capital gains. Plus, of course, a big charitable deduction is involved, too.”

Why nonprofit organizations, particularly universities, are more receptive to this version of the Reverse Annuity Mortgage (RAM) than conventional lenders are, all hands agree, is because the institutions not only have a broad capital base--not subject to shareholder impatience at seeing money tied up for many years--but, because they are institutions, they can afford to play the actuarial waiting game.

The two points are the most frequent explanations for the disinterest among California’s conventional lenders in marketing a commercial application of the RAM.

As Roger Meyer, director of planned giving for the UCLA Foundation, puts it: “In my way of thinking, the more people who move into California, the more difficult it is for me to see how residential property value can become depressed to any great degree. We’re basing our annuities on present value gifts and, if you do enough of these, then you have the general law of averages moving into force.

Will Balance Out

“Some donors are going to live beyond their projected life span, and the value to the institution isn’t going to be as great. But in time this will balance out to the institution’s benefit and to the individual’s, too, for as long as he lives.”

And Pepperdine’s director of planned giving, Peter Wakeman, adds another edge that the universities have over conventional lenders: “As nonprofit institutions, we have tax benefits that we can pass along.

“It means we will pay a lesser rate for an annuity than in a commercial market, and we’re only writing an annuity on the remainder value--not the full value as a commercial lender would. Also, frankly, our margin of safety is higher than with a commercial lender.”

Moving cautiously into this aspect of charitable giving, UCLA, at the moment, Meyer adds, “is most interested in property in the West Los Angeles area, near the university. We see it as a wise investment in future faculty housing. Property out here is very difficult to come by.”

Plans Go Awry

But what happens under a gift annuity if the donor’s plans go awry?

Meyer puts it this way: “Let’s say that I’m a 70-year-old donor who wants to continue living in his home with his wife and have the added income of the annuity. But then, five years down the road, we find we have no choice--we have to move into a rest home. What then?

The university can rent the home and I, as the donor, gets the income from that. I have the economic benefit of that property for as long as I live.”

Perhaps more commonly, though, as attorney Freeman puts it: “If their plans change in the future and the couple decides it wants, or has , to move, the university can sell the home and the value of the donor’s life interest is converted to cash.

“At the same time, the value of the remainder interest held by the university is converted to cash, too--everybody gets paid off.”

Freeman, who advises both donors and institutions on the mechanics of charitable giving, concedes that there can be complications in real estate gifts.

‘Complicates the Title’

“It complicates the title, naturally, so if you ever want to refinance for liquidity, or whatever, it can be difficult to split the ownership. Also, it can complicate the responsibilities between the life owner and the remainder owner. Who buys the new roof? It has to be spelled out very carefully because most donors tend to assume that the institutions should carry the cost of the home. But that’s not the way it is--the cost of maintaining it is a part of the consideration paid by the institutions.”

Whether the lifetime annuity comes about through the life/remainder gift annuity, the USC approach of outright purchase of the remainder interest or through the immediate gift of the house to the university, aren’t the donors’ heirs left high and dry when, sooner of later, the university takes title to the home?

Security for Parents

Essentially, yes. But as attorney Freeman points out: “You have to remember that about 20% of the people who die do so without leaving any heirs, anyway, and another 18% who die still manage to leave something to charity, as well as to their children.

“And, in the other cases, almost invariably the children want to do it. They want to see their parents comfortable and secure. It means a lot more to them than inheriting the family home sometime down the road.

“And so, in spite of some disadvantages, it’s a natural opportunity for universities, at least the larger ones with a strong economic base.”

But what of the older homeowner with a large equity in his home who needs additional income and who also wants to stay in his home, but who has never set foot on the campus of either Pepperdine, USC or UCLA? Do alumni only need apply?

UCLA’s Meyer laughs. “Hardly! While the alumni, of course, are a logical market, UCLA is so widely diversified that a lot of people can feel an affiliation for it without actually having gone to school here. Everybody has a favorite ‘cause’ of some kind, and somewhere here on the campus that cause is being addressed.

“Maybe the donor is simply a Bruin fan.”