Real estate gifts Retained life estates Reverse charitable mortgage

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FAQs: tax-wise real estate gift options

What you need to know about retained life estate vs. charitable reverse mortgage

March 22, 2017 | by Phillip Buchanan


As more Baby Boomers reach retirement age we are seeing greater interest in charitable gifts that help save taxes (pre- or post-retirement) and/or produce lifetime income. In some of these cases, the best gift choice for a donor may involve unlocking the value of appreciation in real estate. Generally, the real estate being considered for any type of charitable gift should have little or no debt (mortgage) attached to it.

The most common types of real estate gifts are (a) outright gifts (deductible at appraised value) and (b) charitable remainder unitrusts, but there are other tax-wise options as well, such as (c) a retained life estate or (d) a charitable reverse mortgage. The latter two are a wee bit more complicated than the average charitable gift, but may be a perfect fit for some donors.

In order to shed more light on these giving techniques, I will explain how each real estate gift option works.

Retained life estate

A retained life estate (RLE) allows a donor to irrevocably donate a home or farm to a charity (such as Duke), while retaining lifetime use and enjoyment of the property. In return, the donor receives a current income tax deduction, which will be higher when interest rates are low—as they are now.

In addition to the value of immediate tax benefits, a RLE may also relieve your family of the burden of dealing with the sale of real estate after you pass away. During your lifetime, the “life tenant” (typically the original donor) will pay applicable taxes, insurance, and ordinary maintenance costs just as they did prior to the gift. 

A qualified appraisal of the property is required to document the gift value. The amount of your tax deduction will be the property’s fair market value (appraised value) reduced by the value of your life estate. Any excess tax deduction that you cannot use in the year you make the gift may be carried over for up to five additional years.

Example of a retained life estate gift:

Jim and Mary are both age 70 and own a farm that Mary inherited 30 years ago. Their children have no desire to move back to the farm in the future. The appraised value of the farm is $1,000,000, which includes a few buildings valued at $40,000. The couple can make a retained life estate gift to Duke University and receive an immediate income tax deduction of $712,772, which they can use to offset other income over the next six tax years. This example assumes an I.R.S. discount rate of 1.8%.

Note: In some circumstances, it may work better for a donor to make an outright gift (deductible at appraised value) and shift the carrying costs for the real estate to the charity. Any pre-existing lease on the property will remain valid through its term.

Charitable reverse mortgage

The term charitable reverse mortgage may be used to describe several types of charitable gift arrangements. These include:

A donor receives cash from a commercial reverse mortgage company. In most cases, the owner of the real estate will need to be age 62 or older to qualify. The cash is then used to fund a charitable gift annuity (CGA) or charitable remainder unitrust (CRUT) with a charity. Since the real estate value risk is no longer an issue, any charity that offers CGAs or CRUTs will be glad to receive the gift. The Federal Housing Administration’s home equity conversion mortgage is the most commonly used source and donors may ask for assistance from reverse mortgage counselors at hud.gov.

A second version occurs when a charity is willing to issue a CGA for property they want to acquire for their mission. For example, Duke may be willing to enter into a CGA in exchange for property located adjacent to its campus. The CGA payments are similar to installment note payments and the donor will also receive a sizeable income tax deduction.

The third version involves (i) a retained life estate gift to a charity, (ii) coupled with either a current or deferred payment charitable gift annuity issued by the recipient charity, for all or part of the value of the charity’s “remainder” interest in the home or farm. The gift annuity payout will often be less than the highest rate recommended by the American Council on Gift Annuities. Given fluctuations in real estate values over the years, the risk to the charity is substantial.  In many cases, the property may be worth less when the charity owns full title and can sell or use the property (after the lifetime of the donors or other “life tenants”). Thus, only a few charities are willing to enter into this type of gift arrangement.

While most of these arrangements are set up during the donor’s life to secure income tax deductions or lifetime income for the property owner, some also work at death to secure estate tax deductions or help provide for a donor’s loved one.

Caveat: When considering any reverse mortgage arrangement, a donor should review the applicable costs, including attorney fees for the transfer of title, appraisal, and other costs.  In other words, donors should seek counsel from someone who is not trying to sell them something.  On the up side, the regulation of reverse mortgages has improved in recent years.

Please contact our office if you would like to explore your real estate gift options. 

Read these related articles about retained life estate or charitable reverse mortgages:

 


Note: Internal Revenue Service cites related to retained life estate gifts in a home or a farm -- See Internal Revenue Code sections 170 (f)(3)(B)(i), 2055(e)(2) and 2522(c)(2) and Private Letter Ruling 9538040. For appraisal factors, See Internal Revenue Code section 170(f)(4), Reg. Section 1.170A-12(b)(2)

About the author

phil-buchanan-headshot

Phillip Buchanan Senior Philanthropic Counsel for Duke University

Phil is a veteran of development and gift planning who considers it a privilege to help good people celebrate the joy of giving. He serves as Duke’s senior philanthropic counsel and helps donors, professional advisors and Duke Development officers evaluate the best options for making a charitable gift to Duke. He has been featured in publications such as BusinessWeek and Kiplinger’s. When he’s not at work, Phil attempts to solve the mysteries of the universe for his three inquisitive young sons.

Phillip Buchanan can be contacted via email or by phone at (919) 681-0467.

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