Estate Planning Strategy
The Charitable Life Estate
By Randy A. Fox

Mar 25 | archive | subscribe

Question: What's the most important part of a jigsaw puzzle? Answer: The cover with the picture on it. Contemplating an estate plan is a little like trying to construct a jigsaw puzzle: The clearer the picture you have of the desired outcome, the easier it is to construct. In fact, too many plans are written with no overall outcome in mind, like trying to build the puzzle without knowing what it's supposed to finally look like.

Often, a piece of the puzzle that is overlooked is the family residence. Many parents mistakenly believe that their children will "want the home." In today's environment, it is more likely that the family is geographically dispersed and the children would be more pleased with receiving the value of the home and its important and memorable contents, rather than the house itself. If the parents are somewhat charitable an interesting, simple and often overlooked strategy is the use of a Charitable Life Estate. Here we discuss some of the advantages as well as some of the precautions when considering a Charitable Life Estate as a planning element.

Gift Agreement Between Donor And Charity
A Charitable Life Estate is a gift agreement between a donor and a charity, involving either a residence or farm whereby the donor gifts the property to charity but retains the right to live in the property, usually until death. This type of arrangement has several advantages for the donor. First, and most importantly, it may satisfy a desired charitable intent. Most gifts are still made by bequest and utilizing the family residence may afford a simple solution to fulfill that need. The family residence isn't income producing and, in fact, the donor won't notice any change in his lifestyle based on the gift.

The Income Tax Benefit
Second, the Charitable Life Estate arrangement provides an immediate income tax benefit. Since there is a completed gift to charity an immediate income tax deduction is available to the donor. The deduction is not for the full value of the residence but for the value of the remainder that will pass to charity at the donor's death (this is called the present value of the future gift).
This computation is somewhat complex but can be easily figured out using one of the many different software packages available. Of course, the residence must be professionally appraised to determine the current fair market value before the calculation is made. Having the benefit of a charitable income tax deduction available may allow the donor to better time other transactions, such as the sale of appreciated securities. For instance, the deduction may offset the impact of a large capital gain. Furthermore, like other charitable deductions, any unused amount may be carried forward for an additional five years.

Third, the residence is removed from the taxable estate of the donor. More than that, however, it is one less "thing" that must be dealt with. For those settling the estate, this is often a very valuable benefit. Dealing with the disposition of a home is often cumbersome. The real estate market could be depressed, the home could be in poor condition and in need of repair or there could be any number of other complications that are easily avoided with the Charitable Life Estate arrangement.

Case Study
Kyle and Bonnie are 62 and 60 years old respectively. Their home is valued by a qualified appraiser at $1,800,000. This value includes the land which is said to be worth $360,000. Only the value of the home itself is used to calculate the gift. A gift of their home to charity with a retained life estate for both of their lives will produce a current income tax charitable deduction of approximately $429,970.

If Kyle and Bonnie are in the 35% tax bracket, the gift could save them $143,000 in income taxes. A life estate is completed by executing and recording a Deed. Unlike many charitable planning tools, this is a relatively simple transaction for the donors. Meanwhile, they will retain the right to live in the house as long as either of them is alive. They will continue to pay all of the costs of maintenance, real estate taxes, utilities and insurance just as they had in the past.

Consider Purchasing Special Life Insurance
Before Kyle and Bonnie have "given away" their home, they may wish to consider the implications of this transaction on their total estate plan. Certainly, their taxable estate will be reduced by $1.8 million that represents their home and, all of the future growth of this asset as well. They may want to replace the value of this lost asset by purchasing life insurance in an irrevocable life insurance trust (ILIT) that would keep the insurance proceeds outside of their taxable estate.

There are many ways to contemplate how much insurance to purchase: they may buy enough to replace the value of the home at today's value; or, they may purchase enough insurance to replace the home less any estate taxes that would have been paid; or, they may buy enough to replace the current value plus whatever it would have grown to over time. There is no right answer, except for the answer that Kyle and Bonnie decide helps makes the puzzle fit together.

What If They Need To Vacate The Home?
There are some additional considerations to keep in mind. Kyle and/or Bonnie could become incapable of living on their own and may need to vacate the home. What happens then? There are several possibilities to consider: they can sell the home and give charity its portion (the remainder value) and keep the life interest portion; they could accelerate their gift by giving their life interest to the named charity and receive an additional income tax deduction; they could rent it to a third party; they could exchange their life interest with the charity in exchange for a gift annuity income stream.

While this article has not discussed many of the technical aspects of Charitable Life Estates, nor has it attempted to discuss all of the potential applications of this type of gift, it should be clear that this type of gift is both powerful and useful for the appropriate family. And, of course, it should only be considered in the context of all of the other planning decisions that make up an entire estate plan. It's only one puzzle piece, albeit an important one. inknowvision.com