Whether it’s buying a home or investing in commercial property, real estate remains a top asset for building generational wealth. Yet, as people age, many find that their heirs don’t want the responsibility of owning or managing a property. Almost 70% of those who expect to inherit a home from their parents plan to sell it, according to a 2023 Charles Schwab survey.
“We are seeing more older adults than ever looking to learn how they can liquidate real estate investments in a tax-smart way,” says Matt Bernstein, chief planned giving officer at Jewish National Fund-USA, a 123-year-old American-based philanthropic organization.
As with any successful investment, the art of disposing of real estate correctly can take as much effort and thought as investing in the first place. Especially considering the government will take a portion of the good fortune.
Bernstein believes that it’s not what, when, or where but rather how people dispose of real estate that can make a massive difference because of the taxes due on the sale of an appreciating or income-generating property.
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One solution that property owners consider is to swap one investment property for another, which allows capital gains taxes to be deferred, commonly referred to as a 1031 exchange. But what if they no longer want the headache of being an owner yet still want the income it provides? An innovative solution is to create a Charitable Remainder Trust (CRT).
“A CRT is an irrevocable trust that lets you donate assets to charity and draw an annual income for life or for a specific time period,” says Bernstein.
When established correctly, a CRT can potentially save taxpayers thousands, says Bernstein. “It enables them to avoid capital gains taxes, provides them and/or their loved ones with income, passes more of the estate to heirs tax-free, and provides vital support to a public charity they support. Additionally, CRTs become more desirable as interest rates soar because higher rates can reduce the actuarial value of the taxable gift.”
A CRT in action
David and Lisa purchased an apartment building 15 years ago and are ready to sell it. They have an adjusted cost basis in the property of $300,000, which is now worth almost $1 million. Still, upon the sale, they will owe nearly $167,000 in taxes when federal capital gains taxes are calculated. Their home state would impose an additional $45,000.
To avoid losing more than 20% of the value of their property to taxes, David and Lisa could donate the building to a CRT. By doing so, they avoid the capital gains taxes owed at the time of the sale, receive a significant charitable income tax deduction based on their ages and other factors of the appraised value of the apartment building when it is donated, and receive an income stream from the trust every year for the rest of their lives. David and Lisa can name one or several charities to receive the remaining interest of their trust when it terminates.
In this scenario, the strategy could provide the following results:
- David and Lisa will receive an annual income equal to 6% of the fair market value of the trust assets every year (about $60,000).
- They will avoid the capital gains taxes due to the sale, saving them more than $200,000 in state and federal taxes.
- They also will receive an immediate charitable income tax deduction of close to $376,000, saving them about $140,000 in federal income taxes and almost $45,000 in state taxes.
- They could possibly save themselves up to $400,000 in estate tax.
- David and Lisa’s gift will leave a legacy to one or more charities they are passionate about.
If David and Lisa are concerned that they are disinheriting their children by giving such a large amount to charity, they can still purchase joint life insurance with a portion of the tax savings or the income the trust was paying. This would guarantee their children could receive the value of the gift free of estate and income tax.
The good news is that a financial institution, a person, or the charities that they support can serve as trustees of a CRT.
To discover how a CRT can benefit you and the causes you love, visit jnflegacy.org or call 800.562.7526.
The calculations in this article are for illustration purposes only and should not be considered legal, accounting, or other professional advice. Your actual benefits may vary depending on several factors.