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John and Sally have a portfolio of apartment complexes that they would like to pass to their two children, Mary and George. The couple purchased one of the complexes many years ago for $4 million and it is now worth $14 million. They also have $1 million in public securities that they would be willing to fund the trust with as well. They had purchased the stock for $500,000 many years ago. The complex is generating fixed income and appreciating at an average rate of 2%. John and Sally are interested in funding a non-grantor lead trust to benefit their favorite charity, but are unsure whether it should be structured with annuity or unitrust payments. The couple contacts their estate planning attorney for advice on how to draft the trust. The attorney recommends funding the lead trust also with the $1 million in securities to add liquidity in case of any incidental costs related to the apartment complex.
The attorney prepares illustrations of both payment structures to highlight the benefits of each. The attorney recommends a 10-year trust term making at least annual payments of 7% to their favorite charity, with the assumption of combined income from the securities and apartment complex generating $1,050,000 of income (7%) with combined conservative asset growth at a rate of 2%. In either trust drafting structure, the trust will not recognize capital gain based on the yearly 2% anticipated growth of the complex and securities, if they are retained within the trust. If the trust sells the securities or the apartment complex, the trust will recognize the capital gains.
If the trust is drafted with 7% annuity payments, the couple will receive the following tax benefits. The trust will create a charitable gift tax deduction of $10,052,385, leaving a taxable gift of $4,947,615. The trust will make annual payments of $1,050,000 for a total of $10.5 million to charity over the 10-year term. Assuming the complex and stock portfolio continue to generate income equal to the annual payments to charity, the trust will not owe income tax. Upon the expiration of the 10-year term, George and Mary will receive the apartment complex and securities with an approximate value of $19,005,664 considering the 2% appreciation growth within the trust.
If the trust is drafted with 7% unitrust payments, the tax benefits would change. The charitable gift tax deduction would be $7,696,125, leaving a taxable gift of $7,303,875. The trust will make a payment of $1,050,000 to charity in the first year and approximate payments from the trust may total $11,497,207. Considering the same 2% appreciation growth, George and Mary will receive the complex and securities with an approximate value of $18,284,916.
The couple realizes the major difference between the two payment structures is the differing amounts to charity and to their children. Understanding a gift of $10.5 million to charity is significant, the couple decides to draft the non-grantor trust with annuity payments to better leverage the gift to their children.
Tom and Lisa have approximately $28 million in assets and are looking for a tax-favored way to pass their $4.5 million office building to their nephew, Ron, age 40. He is relatively successful financially, but his aunt and uncle desire to increase his retirement security. The office building is generating about $250,000 in annual income and is expected to continue generating that amount for many years to come due to long-term fixed leases with the tenants. Tom and Lisa are interested in retaining the income generated from the office building during their lives, but would like to use the income stream to benefit their favorite charity once they pass on and eventually give the building to Ron. With this information, they approach their estate planning attorney who recommends a testamentary annuity lead trust with zero estate tax. Excited about the possibilities, they ask the attorney to draft the trust.
The attorney recommends the trust be funded with the $4.5 million office building and $500,000 in public securities to provide liquidity. The attorney recommends drafting a testamentary lead trust making 7% annual annuity payments for a term of 14 years. At their passing, approximately $22.7 million will be transferred to their heirs through their estate plan and the office building and securities will fund the lead trust. The attorney assumed the unified credit based on the $11.7 million current value for 2021. With a charitable estate tax deduction of $4,686,395 and estate costs of 1%, the net taxable estate is reduced to $23,033,605. The tentative tax of $9.1 million is reduced by the unified credit, including portability of unused spousal exclusion to the surviving spouse, and the charitable estate tax deduction created with the testamentary lead trust producing a net estate tax of $0. The trust will make annual payments to charity of $350,000 for a total of $4.9 million over 14 years. The trust will not owe income tax on the payments to charity if the charitable payments exceed the trust's income. Upon the expiration of the 14-year term, the office building and securities will be transferred to Ron. Happy with the zero tax estate results, Tom and Lisa include the trust in their estate plan.
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Charitable Gifts of Real Estate – Part II
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