Trust Provides Donors Income, Tax Benefits for Generosity
Longtime Westwood residents Alan and Elaine Armer have accumulated a lot of real estate during their 44-year marriage, but, aside from a living trust created in 1979, they hadn’t given too much thought to estate planning.
The energetic couple have always been otherwise occupied.
Alan, now 71, spent part of his working life as a television producer. He produced the first three years of “The Fugitive” (1963-1965) before moving on to other TV assignments. Then, after leaving the industry 14 years ago, he began teaching screenwriting and directing at Cal State Northridge, and he’s still there.
Meanwhile, Elaine, 63, was busy modeling, raising their four children and, during the ‘70s, decorating houses the couple had purchased as income property.
Several months ago, however, the Armers focused their attention on estate planning after a relative urged them to do something to minimize future taxes on their estate, which amounts to $4.75 million.
So, with the guidance of an estate planning attorney, the Armers have created a charitable remainder trust (CRT), a device that allows owners of mortgage-free properties to give the property to their favorite charity and to receive an assortment of tax advantages and a lifetime income in return.
Simply stated, a CRT is a device by which a person transfers property to an irrevocable trust and retains lifetime income from the sale of that property. At death, what remains in the trust goes to charity.
What the Armers did with the help of their attorney was to create a CRT that contains their $2.5 million Malibu beach house. When the trust sells the property--it is now on the market--and invests the proceeds, the Armers will receive income during their lifetime. The designated charities will receive what remains in the trust when the last remaining spouse dies.
What makes a CRT so advantageous?
--It removes a piece of highly appreciated property from your estate.
--It allows you to avoid capital gains taxes when the property is sold.
--It allows you handsome income-tax deductions because you’ve given the property to charity.
--It provides you with lifetime income, which is taxable unless it comes from tax-exempt bonds.
--And, if you become disenchanted with the charity you originally named as beneficiary, it allows you pick another one.
How is all of this achieved? Because the CRT is irrevocable, property put into the trust is out of your estate because it’s out of your hands forever. Once created, the trust is administered by a trustee, which could be you or a trust company or the trust department of a bank.
Because the trust is a tax-exempt entity, no capital-gains tax is paid when it sells the property. This allows 100% of the sale proceeds to be utilized to generate income.
Because the IRS looks favorably on charitable donations, it grants generous income-tax deductions to those who make them.
Because one of the conditions of the trust contains an income component for the donor, you receive an annual income for a specified period of time--usually as long as you live.
All of these elements suited the Armers’ estate planning goals: They wanted to generate additional income for their retirement, they wanted to avoid capital gains, earn income tax advantages and, perhaps even more important, they wanted to provide financial support for two favorite charities.
There are only two prerequisites to qualify: You must own some highly appreciated real estate and--perhaps even more important in your final decision--you must be willing to give it away forever to some favorite charity. If you’re giving away your home, a third requirement is that you must be willing to move when the home is transferred to the trust.
The Armers, who have strong ties to Cal State Northridge’s Radio, Film and Television Department and to Jewish Big Brothers of Los Angeles, have named both as recipients of the trust proceeds when they die.
Cal State Northridge and Big Brothers are, in legal terminology, “remainder beneficiaries,” which means they will share what remains in the trust after the Armers die. The Armers are “income beneficiaries,” meaning they earn income from the trust while they are alive.
Like the qualified personal residence trust (QPRT), your age and the duration (or term) of the trust are important factors to consider in deciding whether this is the appropriate vehicle for you.
The older you are, the larger the tax deduction. The reason is obvious: The older you are, the sooner the charity will get what remains in the trust.
IRS tables are used to calculate the income you will receive based on the value of the trust, but you must specify a minimum of 5% as an annual return. The Armers have selected an 8% return. Based on the expected value of their CRT ($2.5 million), their estimated annual income will be $200,000.
When considering a charitable remainder trust, you’ll need to ask yourself some pragmatic and philosophical questions: Does it make economic sense for you? Do you own highly appreciated real estate that you’d like to permanently remove from your estate? And, perhaps even more important, do you feel benevolent? Do you want to make a significant gift to a favorite cause or a favorite university?
The market value of your property is an important component in these considerations. If it’s worth more than $1 million, the designated charity is likely to absorb all the legal fees (ranging from $2,500 to $5,000) involved in preparing the trust. But even if the intended gift is less than $1 million, most charitable institutions and schools are eager to work with prospective donors, estate planners report.
From the donors’ viewpoint, however, a CRT makes financial sense only if your free-and-clear property is worth $250,000 or more, according to estate planning attorney Jane Peebles of Los Angeles. “When you consider the cost of setting up the trust and the benefits of the tax break, anything less isn’t really worth it,” she said. “But in Southern California, that covers a lot of real estate.”
A CRT prepared by the charity’s legal staff is usually reviewed by your own attorney to assure it contains all the important conditions. One particularly important condition that these trusts should contain is the freedom to change the beneficiary--just in case you become dissatisfied with your original choice. You can’t pull out of the trust but you can change charities.
The Armers said they paid a total of $2,000 for legal consultations relating to the trust, and that included the all-important review.
Like other estate planning techniques described in this series, such a trust is complicated and needs an estate planning attorney to prepare or, in some cases, review.
How the CRT Works
Here’s a hypothetical example of how the charitable remainder trust works.
You’re an unmarried 67-year-old retired librarian who owns a highly appreciated rental duplex that’s worth $400,000.
You want to sell the duplex and invest the profit to supplement your Social Security and pension, but selling involves capital gains taxes that would minimize that profit. In this example, you would face state and federal taxes of $160,000, leaving only $240,000 to invest.
On the other hand, you can give that duplex to a charity by way of a CRT. The CRT is tax-exempt, so when the trust sells the duplex, there are no capital gains, and the trust is able to invest the entire $400,000 to provide you with at least a 5% return--$20,000 annually, in this case. Then, when you die, the charity you’ve named in the trust receives whatever funds remain.
You gain one other benefit as well: generous income-tax deductions for having made a charitable gift. Those deductions can be carried forward for five years’ worth of tax returns.
You can also receive the same benefits if you create a charitable remainder trust and put your home into it. The caveat here, of course, is that you must be willing to move once the home is transferred to the trust.
Although the trust is irrevocable, you do have the option of changing the beneficiary if you become disenchanted with the first charity you have selected.
