How Real Estate Investors Can Pay Zero Taxes! - Part 5 Let’s review the main benefits of a Charitable Remainder Trust:
30.
•
For income tax and transfer tax purposes at the time the assets are placed
in the trust.
•
The exemption from capital gains tax on the sale of appreciated property
donated to the trust.
•
Payments from the trust property provide income to the trust beneficiary.
•
The value of the property donated to the trust is excluded from both gift
and estate taxes.
Example of Trust Benefits
•
You own property (one or many) worth $1,000,000 after subtracting
costs of selling the property. You basis in the property is $100,000.
If you sell the property, you will have to pay capital gains tax like this:
Sales Price $1,000,000
Basis 100,000
Profit 900,000
Fed & State tax 300,000
Net after tax 600,000
If you invested the $600,000 at 10% your yearly income would be $60,000.
•
If you give the property to a charitable remainder trust and the trust sells
the property, it will pay no tax.
If the trust pays a 10% annual annuity you will receive increased income,
like this:
Sales Price $1,000,000
Basis 100,000
Profit 900,000
Fed & State tax 000.000
Net cash after tax 900,000
Annual Income at 10% 90,000
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An increase in income from $60,000 to $90,000 per year is a 50% increase.
That’s why you must consider using a CRT!
CRTs work best when combined with other strategies, especially if
you want to provide for your heirs while helping a charity.
CRTs don’t necessarily have to reduce the amount originally intended
for your heirs if you do some clever planning. The money saved though tax
deductions and capital gains avoidance can be applied to your heir’s
inheritance through other means, such as life insurance.
Example: The trustee places into a charitable remainder trust a rental
property whose current fair market value is $1 million with a cost basis of
$50,000. The trust then sells the property saving in excess of $250,000 in
capital gains taxes. That leaves more money available to generate the
income necessary to pay the income beneficiary.
This added income can be used to purchase a life insurance policy or
to set up an irrevocable life insurance trust for your heirs. The insurance
payoff equals the value of the assets you placed in the CRT. So you are able
to pass the full value of your estate on to your heirs, just by a roundabout
way. This “wealth replacement trust” has the added benefit of being
sheltered from estate taxes.
Foundations
Another powerful strategy is to use a family foundation as the charity
beneficiary of the Charitable Remainder Trust. The CRT document could
specify that upon your death (or second to die if husband and wife) the
holdings of the trust would be transferred into a family foundation that
would be managed by your heirs. The foundation could provide heirs with a
generous salary income.
Here are some of the reasons you might find a foundation attractive:
32.
1. It will provide the family a method of controlling both the
disbursement of funds to charities, and the charities use of
those funds.
2. It can allow the heirs to achieve influence and stature in either
the local community or within a charitable or religious
organization.
3. It becomes a long-term even perpetual institution, which can
carry the family name, wealth and legacy far into the future.
4. It avoids unnecessary estate, gift, capital gains and income
taxes on family wealth.
5. It can provide income to current members and future
generations of the family, either for their management of the
foundation or as compensation for charitable activities they
directly perform.
6. The foundation formalizes the family’s plans and goals
regarding charitable activities.
7. It involves family members more directly in the charitable
activities.
What Type of Foundation
The charitable foundation described here is termed a “supporting
organization” in the federal tax laws. The supporting organization is a
relatively new type of IRS recognized tax exempt charitable organization. It
was created in the early 1970s under Section 509(a)(3) of the Internal
Revenue Code.
Supporting organizations have much more flexibility, with better tax
advantages for the family, than the more familiar family charity known as
the “private foundation”. The reason that supporting organizations are more
tax advantaged than private foundations is that Federal Tax laws treat the
supporting organization the same as a public charity.
The supporting organization has the same tax status as major charities
like the Red Cross, Cancer Society, etc. The reason that supporting
organizations are more flexible than private foundations is that they are not
governed by the onerous excise tax rules, as private foundations are.
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Supporting organizations are treated as “50% organizations” under
federal tax laws just as public charities are.
That means that an individual may deduct charitable contributions
from their tax returns of up to 50% of their adjusted gross income if the
supporting organizations, churches, non-profit schools and hospitals,
governmental agencies and public parks are generally all 50% organizations.
Supporting organizations do not pay income taxes and are not
required to distribute 5% of their net value each year, as private foundations
do. The supporting organization has a clear advantage over the private
foundation for family use.
A well-organized supporting foundation is created as a trust and is run
by a family chosen Board of Trustees. The Board can in fact be the family.
Donors can be anyone whether or not they are family members or family
entities. The Board can engage a person(s) to manage the Foundation and
pay that person a salary, plus expenses. These employees could be family
members.
The Foundation can be funded with family or other privately donated
assets, or it may engage in public fund raising.
The Foundation will have its own tax exempt Federal Tax ID and will
file an annual information return with the IRS. As a supporting organization
under Federal Tax laws the foundation must name one or more “qualified”
public charities as beneficiary of the foundation. The beneficiary charity is
knows as a “supported organization” or “supported beneficiary
organization”. The Foundation must then either carry out some of the
charitable activities of the beneficiary charity, or must provide income to the
beneficiary charity so that it may carry out charitable activities for itself.
Since the Foundation is treated like a public charity for Federal Taxes
purposes, gifts to it are deductible from the donor’s income tax return, and
are not subject to gift taxes. This is true for all donors, whether family
members or not. Gifts of appreciated assets will avoid all capital gains taxes
for both the donor and the Foundation.
34.
Gifts may be virtually anything, including cash, real or personal
property or business interests.
Once there are assets in the Foundation they may be invested in
almost anything, where they will then grow tax-free.
In another words, after assets have passed from your CRT to your
Foundation any additional gifts are also tax deductible.
Laws define charitable activities broadly enough that they can include
virtually anything that is generally deemed to benefit humankind in a nonself
serving manner. This can range from supporting the founder’s church,
to educational pursuits on almost any subject matter, social or religious
work, scientific pursuits, support of athletic activities and much more.
The Foundation can be named as the charitable beneficiary of a
charitable remainder trust.
Another application is to name the Foundation as the heir or
remainder beneficiary for a portion of a family’s assets, through either a will
or a traditional family trust.
The children or other heirs of the family can benefit by becoming
Foundation trustees and/or employees.
Supporting foundations may not passively and simply provide funding
to some other charity. For example, the Foundation could not simply write
checks to some church organization for the church to then control
disbursement of those funds. The Foundation must take an active role in
charitable works and projects. An active Foundation might actually run a
church’s youth program, as opposed to simply funding the program.
The Foundation may be active enough, even though it only pays
money to other charities. This might be accomplished by undertaking a
research program to find deserving charitable projects and organizations,
which need funding. After the research was complete the Foundation could
then provide some oversight or monitoring to ensure that the funds are spent
as planned.
35.
Consult a qualified estate planner or attorney for exchanging, trust and
foundation guidance. Rules and tax laws change.
We have based this publication on the rules, laws and tax rates in
effect when these words were written. This is not mean to be legal advice.
The bottom line is that 1031 Exchanges, Charitable Remainder Trusts
and Supporting Foundations can be a powerful trio of wealth building and
protecting strategies.
And best of all, they allow you to pay….
Zero Taxes!
Appendix
Estate Tax Liability
Here is an overview of estate tax law to remind you of the awful mess
congress has inflicted upon us and why we should do all we can to avoid it!
The estate tax is progressive, so as the value of your estate increase,
planning becomes more important. The marginal estate tax rate on a transfer
of $10,000 is 18%, while the rate on a transfer in excess of $3,000,000 is
55%. The amount of tax computed is increased by 5% for taxable estates
between $10 million and $17,184,000.
36.
This 5% surcharge eliminates the benefit of the graduated tax rates,
resulting in an effective tax rate of 55%. Prior to the Taxpayer Relief Act of
1997, the 5% surcharge applied to taxable estates between $10 million and
$24.1 million. The higher threshold eliminated the benefit of the unified
credit. Congress may reinstate the unified credit surcharge in the future.
The estate tax is really a transfer tax because it applies to property
transfers during lifetime (such as gifts) and at death (such as inheritances).
As a result, an effective estate plan should consider both lifetime giving as
well as the transfer of property at death. All such transfers may be subject to
tax. More importantly, lifetime planning can significantly reduce any
transfer tax liability at death.
Some types of transfers are excluded in determining the amount of a
transfer that is subject to tax. For example: lifetime gifts from an individual
of less that $10,000 per recipient per year are generally excluded from any
transfer tax considerations. The $10,000 exclusion will be adjusted
periodically for inflation.
In addition to the $10,000 annual exclusion, every individual taxpayer
can transfer a certain amount of property during his or her lifetime without
paying estate or gift tax due to a lifetime exemption amount. This
exemption amount is used to calculate the credit available to offset the
unified transfer tax. The exemption amount will be $1 million in 2006. The
illustration below shows how the exemption amount will increase and the
amount of the corresponding credit:
Increase in Lifetime Exemption
Year Exemption Credit
1999 $650,000 $211,300
2000-2001 $675,000 $220,550
2002-2003 $700,000 $229,800
2004 $850,000 $287,300
2005 $950,000 $326,300
2006-later $1,000,000 $345,800
37.
Estate administration expenses and debts can be deducted before
computing any estate tax liability.
For a married couple, the primary deduction that reduces any gift or
estate transfer tax is the marital deduction. This deduction is unlimited and
permits one spouse to transfer any or all property to the other spouse free of
tax. With proper planning the estate transfer tax for married individuals can
be deferred until the death of the surviving spouse.
Amounts given to charity during lifetime or at death generally are not
subject to any transfer tax.
After all exclusions and deductions have been considered, a tentative
tax is computed on the remaining amount of the transferred property. This
tax can be offset by the applicable credit amount based upon the applicable
exemption amount shown in the previous illustration. Any estate with a total
value less than the exemption amount will generally not be subject to any
federal estate taxes.
You can insure that your estate will be less than a taxable amount by
transferring part of it into your CRT.
Although the marital deduction allows for an unlimited amount of
property to pass between spouses without transfer tax consequences, this
deduction does not eliminate the need to develop an estate plan for the
overall family. A simple estate plan under which everything passes to the
surviving spouse may eliminate any taxes in the estate of the first to die;
however, additional taxes may be due upon the death of the surviving
spouse. The marital deduction should be coordinated with each spouse’s
unified credit.
State death or inheritance taxes may have to be paid in addition to
federal transfer taxes. Many state transfer taxes are patterned after the
federal tax, but there are differences. State taxes may be incurred even when
there is no federal tax.
Many of these costly complications can be avoided using the 1031,
CRT and foundation strategy, but only with professional guidance.
38.
Sample Charitable Remainder Trust
On this CDROM you will find sample CRT documents. Do not use
these document. They are for illustration purposes only! The strategies
discussed in this manual are not for the do-it-yourselfer. Seek the advice of
a well-established trust or estate-planning attorney when planning to use any
of these advanced strategies.
Nothing in this manual should be construed as legal advice. The
authors have simply related information gained from they own activities and
research.
Go Forth and Prosper! This document and accompanying materials are designed to provide authoritative information in regard to the subject matter covered in it. It is for illustration purposes only and presented with the understanding that the author and publisher are not engaged in rendering legal, accounting or other professional opinions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. |
