16TH ANNUAL PROFESSIONAL ADVISORS SEMINAR
Advisor News
Lifetime Income for Family Outcasts – in Privacy
Mrs. Haskell is planning her estate and wants to provide for a charitable organization and also create some financial security for her wayward son, Eddie, who has a history of bad behavior. The challenge: She doesn’t want her other children to find out that she’s doing anything for Eddie, who is not well thought of within the family. She feels she can’t help him through a will or living trust because the family surely would learn of it. What strategies might be available to Mrs. Haskell?
Life income gift arrangements may help in families where certain relatives are considered outcasts or lack ability to manage money. Charitable organizations that offer charitable gift annuities generally will preserve confidentiality regarding any gift. Mrs. Haskell could provide Eddie with either an immediate or deferred payment annuity, and no one has to know. If the value of her son’s life annuity is less than $13,000, Mrs. Haskell need not file a gift tax return (for an immediate payment gift annuity). A gift tax return would be required for a deferred payment annuity, which is a future interest that does not qualify for the gift tax annual exclusion, but this may not be an issue if Mrs. Haskell won’t owe estate taxes.
Could she establish a “testamentary” gift annuity for Eddie outside her will? She might establish a joint annuity for herself and Eddie as survivor beneficiary. Based on the “flexible deferred gift annuity” concept, she also could arrange a deferred annuity for Eddie with a starting date likely to occur after her death. The contract would provide that the start of annuity payments will be moved up to the year of her death, but with reduced annual payments (that are set out in a schedule that preserves actuarial values reflecting the original transfer). Even if the charity does not offer gift annuities, it may offer to act as trustee of a charitable remainder trust, which also could provide income and money management for a beneficiary.
Copyright © by R&R Newkirk. All rights reserved.
Investing in a Commercial Annuity within a CRT: A Closer Look
The IRS has issued a private letter ruling permitting investment of the assets of a charitable remainder annuity trust in a commercial annuity. The donor plans to transfer appreciated real property to the CRAT, which will contain a provision allowing purchase of an annuity that would guarantee to pay the trust a sum equal to or greater than the amount distributable to the donor over her life. The trustee would be limited to purchasing an annuity from a top-rated company. After the annuity is secured, the trustee could distribute any amount of trust corpus to the charitable remainder beneficiary during the trust term. The trust would possess all incidents of ownership in the commerical annuity and would be entitled to all payments, which would then be used to pay the required annuity to the donor.
The IRS noted that Reg. §1.664-2(a)(4) provides that no amount other than the annuity interest may be paid to or for the use of any person. However, if an amount is transferred for full and adequate consideration, it is not considered paid to or for the use of any person. The IRS ruled that including the provision in the trust document will not prevent it from qualifying as a charitable remainder trust under IRC §664(d)(1) (PLR201126007).
What are the advantages and possible disadvantages of investing CRAT assets in a commercial annuity?
In this case, the donor was able to convert appreciated real estate into a lifetime annuity without having to pay capital gains taxes, which might include 25% recapture of depreciation (no tax is due upon transfer of real estate to the CRAT or when the trustee sells the property). On the other hand, 100% of the trust payments will be taxed as ordinary income, with no potential for favorably taxed dividend, capital gain or tax-free income. (Under IRC §72(u)(1), no tax-free return of principal is available if the annuity holder is a trust.)
From the charitable remainder beneficiaries’ standpoint, there is potential for early distribution of assets left over after purchase of the annuity. On the other hand, purchase of the annuity may exhaust most of the trust assets, reducing the amount passing to charities when the trust ends. Furthermore, in many jurisdictions the trust may face an issue with state diversification requirements.
Comment: A different strategy worth considering by the donor might have been a charitable gift annuity, which would have resulted in the same charitable deduction as the CRAT, while offering potentially better taxation of the annual payments (partly capital gain and tax-free return of principal). A major challenge, of course, is whether the issuing organization can quickly sell the real estate to fulfill the annuity obligation.
Copyright © by R&R Newkirk. All rights reserved.
Mortgaged Property and Charitable Remainder Trusts
Careful planning is required when an individual wishes to transfer mortgaged property to a charitable remainder trust. In general, the trust will be disqualified, based on a private letter ruling (PLR 9015049) that held the grantor in such a case would be considered the owner of the trust. Having said that, it must be pointed out that a substantial amount of the real estate in the United States is mortgaged, so gift planners should explore avenues to make mortgaged property “work” in a charitable remainder trust. What strategies are available?
• The donor could sell an undivided portion of the property to the charitable remainderman – enough to allow the donor to pay off the mortgage, although there will be some capital gain recognition. Once the property is free, the donor can transfer the remaining undivided interest to the trust. When the property is sold, charity will recoup its purchase price.
• If the donor can persuade the mortgage lender to accept other collateral for the loan, the debt can be lifted from the gift property, allowing unencumbered transfer.
• The mortgage lender may agree to release part of the mortgaged property (e.g., one-half). The donor keeps the mortgaged half, transferring the unencumbered portion to the trust.
• The donor can simply pay off the mortgage.
Other proposed solutions to the mortgage problem include an agreement to indemnify the trust for any losses occasioned by the presence of mortgaged property and conversion of the real estate to partnership or LLC interests that were then transferred to a CRT. For further discussion, see pages 7-104(u) to 7-105 of the Charitable Giving Tax Service.
Copyright © by R&R Newkirk. All rights reserved.
What to Do with “Loss” Property?
“Loss” property is property which, if sold, would produce a deductible loss. The consequences of giving such property to charity are illustrated by the following example: Smith bought some XYZ stock in 2006 for $10,000. In 2011, when the stock is worth $9,000, he gives it to a university. Smith’s contribution of $9,000 is not subject to the 30% of AGI deduction limitation (because the stock wouldn’t produce any long-term capital gain if sold). Instead, it is subject to the 50% of AGI ceiling and is deductible as though he had given cash. However, Smith does not get to claim the $1,000 decline in the stock’s value as a capital loss. What Smith clearly should have done was to sell the stock, realize the loss, and donate the proceeds to the university. His charitable deduction would be the same, but his overall tax savings would be increased.
Copyright © by R&R Newkirk. All rights reserved.
Applicable Federal Rates
September 2011: 2.0%
October 2011: 1.4%
November 2011: 1.4%
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