A Money & Family study found that two-thirds (68%) of homeowners plan to leave a home or property to heirs, especially if one of the adult children lives nearby. This trend is picking up steam with housing prices and mortgages out of reach for many young adults and inventory extremely limited. On the surface, it’s a generous gesture and potentially advantageous for estate planning. But that dream can become a nightmare without the right planning in place.
First, the kids may prefer to have the cash from selling the home instead of the real estate itself. That’s especially true when upkeep, taxes and intra-family squabbles are factored in. Responsibility for maintaining the home may also make it harder for adult children to relocate to other areas of the country for career opportunities or a better lifestyle.
Fortunately, there are better ways for your clients to preserve their legacies and pass along assets to the next generation, especially when multigenerational planning is at play. Smartly donating a home to charity, while retaining the right to live there can be a win-win all around. That’s where you can bring significant value to your client and help their charitable contributions make a bigger impact.
Four Stratgies
Here are four strategies for donating a home to charity:
1. Charitable life estate (CLE). A CLE allows the parents (donors) to donate their home, vacation home or farm to charity and continue to live there for life. They also receive a current income-tax deduction for the “donation.” They must continue paying property tax, insurance and other upkeep expenses, but the property is out of their estate for good when they pass away. The charity will then sell the property and use the proceeds to support its philanthropic purposes. Again, the property is now out of the parents’ estate, thus saving the heirs potentially millions in federal and state estate taxes. I’ve even seen cases in which the charity sells the property back to the kids at fair market value after the parents pass -- if the property is in good condition and has strong sentimental value to the kids.
The parents can also do a partial CLE, especially for vacation homes. They can donate the property to a charity but continue to use it for themselves or family gatherings for say, eight weeks a year. Meanwhile the charity can use the property during the remaining 44 weeks of the year for retreats or other functions.
If the family maintains the property in good condition, they receive a charitable deduction for the present value of the gift to be made when they pass. Further, they don’t have to donate the property entirely. Again, the parents pay all the expenses while alive and get the deduction at the time of transfer.
Note: When donating property through a life estate, the donor or other resident must maintain all ongoing property taxes and maintenance of the property while they’re living in it. The donor or resident can’t damage or devalue the property or let it fall into disrepair. The donor or resident also can’t sell the property unless it’s done with the cooperation and approval of the charity, which receives a calculated share.
For example, several years ago, we worked on a case in which an elderly woman could no longer afford the taxes and upkeep of her $10 million house. By donating the house, she earned an immediate tax deduction of $7 million to $8 million. But she didn’t use the tax deduction because she didn’t have any income. So, we exchanged the deduction for a $58,000 per month gift annuity, which enabled her to stay in the house for the rest of her life. When she passed, the gift annuity ended, and the charity received the spacious house worth millions.
2. Qualified personal residence trust (QPRT). A QPRT is a specific type of irrevocable (non-changeable) trust that allows a couple to remove a personal home from their estate to reduce the amount of gift tax incurred when transferring assets to children or other beneficiaries. QPRTs allow the owner of the residence to continue living there for a period of time with a retained interest in the house. Once that period is over, the interest remaining is transferred to the children or other beneficiaries as a remainder interest.
Depending on the length of the trust, the value of the property during the retained interest period is calculated based on Internal Revenue Service applicable federal rates. Because the owner retains a fraction of the value, the gift value of the property is lower than its fair market value, thus lowering its incurred gift tax.
3. Charitable remainder trust (CRT). A CRT is a split-interest giving vehicle that allows the donor to pursue their philanthropic goals while still generating income. The grantor (for example, a couple) donates an income property and receives a partial tax deduction at the time of gift. Typically, this is done in anticipation of a sale and is meant to avoid long-term capital gains tax. They continue operating the property and enjoying the income it generates during their lifetime. After both parents pass away, the remainder of the trust is donated to one or several designated charitable beneficiaries, which are usually public charities.
Note: Unlike a CLE or QPRT described above, the donor can’t continue living in the property while still alive if they transfer it to a CRT.
4. Life insurance. Client can also use life insurance for property-related estate equalization. For example, suppose a widow dies and leaves a lake house worth $900,000 to her three adult children. The two sons live far away and want to sell it immediately. The daughter, who lives nearby, really wants to keep the vacation home. To compensate the two sons, the daughter would have to pay them $600,000 immediately—money she doesn’t have. That’s where life insurance in an estate plan can be used to fill the gap and equalize an estate inheritance among heirs. In this example, the daughter would get the lake house in its entirely while the sons would receive death-benefit proceeds to make up the difference.
Randy A. Fox, CFP, AEP is the founder of Two Hawks Consulting LLC. He is a nationally known wealth strategist, philanthropic estate planner, educator and speaker.