Tax issues Investment Analysis

Trust-Worthy Tips

Charitable gifts can be a tax-wise alternative for investors.

Charitable remainder trusts are unique and powerful giving tools with useful applications in commercial real estate. CRTs often are employed to address the three biggest tax hurdles real estate investors face: current income tax, capital gains tax, and estate tax. In addition, with CRTs donors can make significant contributions to their favorite nonprofit organizations.

Commercial real estate professionals can structure CRTs to help clients accomplish their specific charitable, tax, and financial goals. Generally, the most basic CRT structures involve the following steps:

1. Client establishes a personal CRT with the help of professional advisers.

2. Client transfers property (usually a highly appreciated investment) to the trust via a quit-claim deed.

3. Client receives an immediate current income tax deduction, which can be rolled over for up to five additional years if necessary, to help offset income from other sources.

4. CRT sells the property incurring no capital gains tax.

5. CRT makes annual payments to the client for the rest of the client's life, similar to a pension or annuity.

6. Upon the client's death, all remaining assets in the CRT are transferred to the designated charity estate tax-free and the CRT dissolves.

While this is a simplified explanation of the general processes involved in creating CRTs, many variations can be applied to fit each client's unique circumstances. The following examples highlight possible CRT scenarios in common situations commercial real estate professionals and their clients encounter.

Capital Gains Tax
Bob owns a piece of raw land worth $3 million with almost no cost basis, meaning he'll face a capital gains tax bill of $450,000 if he sells, leaving him $2,550,000 to reinvest. However, in the event Bob passes away, his investment will be subject to an estate tax of $1,173,000 (using the maximum 46 percent bracket).

Following the steps outlined above, Bob could use a CRT to sell the land, eliminating the capital gains tax. The CRT then would have the entire $3 million to reinvest to produce income for Bob, and none of the money would be subject to death taxes in the event Bob passes away.

1031 Exchanges
Two opportunities allow taxpayers to utilize CRT structures in conjunction with tax-deferred exchanges. The first uses a CRT as an alternative to a 1031 exchange. Whereas the exchange postpones the tax bill, a CRT eliminates it and provides the client with an immediate tax deduction to offset other income.

CRTs' second use assists clients who have completed 1031 exchanges in the past. Many clients have substantial gains built up in various properties as a result of executing several exchange transactions. In some cases clients may want to sell but feel trapped and unable to get out of their investments without completing another exchange. CRTs may be an excellent alternative to consider in these instances.

Income-Producing Property
The previous examples assume a property will be sold and capital gains tax is a concern. However, a property does not have to be sold as part of a CRT strategy.

For instance, suppose a client who owns rental property has tax and charitable giving needs but doesn't want to give up the rental income. This client can transfer the rental property to a CRT and have the trust pay the rental income to the donor each year. The upfront tax deduction will help the client net more after-tax cash than in previous years and may help offset income for up to five years. The property is removed from the estate for death tax calculations, allowing the client to leave a tremendous legacy to his favorite charity.

Business Sales
Business owners who retire and sell their businesses (and/or associated real estate holdings) often are concerned with the sale's tax ramifications as well as generating sufficient income to support their lifestyles. CRTs address both issues.

Assume a business owner transfers 50 percent of his stock in a closely held company to a CRT. When the business sale is completed, this portion of the transaction is tax-free and the deduction generated by using the CRT helps to offset the tax bill from the other 50 percent. Since the trust will pay income to the former business owner for life, it acts like a personal pension.

Why Use CRTs?
CRTs are popular in areas where commercial real estate values have increased dramatically. Specifically, real estate pros can use CRTs as marketing tools to convince sellers who might be inclined to hold property due to capital gains tax concerns. Since one of the principal purposes of CRTs is to provide income annually, commercial real estate brokers can use CRTs to help clients convert raw land into income-producing property. Clients will enjoy a sizeable tax deduction upfront and the land sale will not incur capital gains tax.

To best learn how to advise clients on the nuances of CRTs, commercial real estate pros should consult qualified professional financial advisers who are knowledgeable in this field. It may be possible to collaborate on marketing efforts such as seminars to educate property owners on the potential tax advantages of using CRTs.

Commercial real estate brokers also should make themselves available as a resource to local charities. Nonprofits can be a referral source when donors wish to use real estate as part of their giving strategy. This may include selling property the nonprofit has accepted as a gift, assisting with a CRT strategy, providing a market analysis, or even helping the nonprofit acquire new property for its operations.

As with any advanced tax strategy, CRTs may not be applicable for all clients. However, for those clients who are charitably inclined and have significant tax concerns, CRTs can be a saving grace. Commercial real estate pros who can bring these types of solutions to their clients can gain valuable market share in their local communities.

Joseph O. Luby III, CFP

Joseph O. Luby III, CFP, is president of Financial Solutions in Henderson, Nev. Contact him at (702) 451-1158 or info@financialsolutionsnv.com.

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