In today’s financial landscape, investors often find themselves at a crossroads when it comes to exiting their real estate investments. Many property owners are familiar with the 1031 Exchange as a way to defer taxes, but what happens when you’re ready to retire from managing properties? Planning expert Lon Dufek (CFP®, CPA) and Equity Advantage’s own Tina Colson-Jones explore a powerful alternative exit strategy known as the Charitable Remainder Trust (CRT).
What is a Charitable Remainder Trust (CRT)?
A Charitable Remainder Trust is a versatile financial tool designed to help investors manage their assets while supporting charitable organizations. Essentially, a donor transfers cash, securities, real estate, or other appreciated properties into a trust in exchange for lifetime income or income for a specified term. Upon the death of the donor or the end of the trust term, the remaining assets in the trust are distributed to one or more charitable organizations of the donor’s choice.
Why Consider a CRT?
Many investors find themselves exhausted from the responsibilities of property management. As they age, the appeal of selling their investment properties becomes more pronounced. The CRT provides a compelling alternative to the 1031 Exchange, particularly for those who are uninterested in acquiring new properties. Here are some of the significant benefits:
- Bypass Capital Gains Tax: When you transfer an asset to a CRT, any capital gains tax that would ordinarily apply upon the sale of that asset is bypassed.
- Increased Income: CRTs often provide a higher income stream than traditional rental income, making them an attractive option for retirees.
- Charitable Deduction: Donors receive a charitable deduction based on the fair market value of the assets that will eventually go to charity.
Case Study: Turning $500K into $2M in Benefits
To illustrate how a CRT works, let’s consider a hypothetical couple, John and Marilyn White, aged 70 and 65. They own a rental property valued at $500,000, which they purchased for $100,000. If they were to sell this property, they would be subject to capital gains tax on a $400,000 gain.
By transferring this property into a CRT, they can achieve several financial benefits:
- Receive a tax deduction of approximately $179,655.
- Save around $63,000 in taxes if they are in a 35% tax bracket.
- Receive an annual income of at least $25,000 for their lifetimes.
This strategy not only helps them avoid capital gains tax but also allows them to support their favorite charities after their passing. Over their life expectancy, they could potentially generate around $900,000 in income from the trust.
How Does Income Work in a CRT?
Many people are curious about how the income generated from a CRT functions. The income can vary based on the value of the trust assets. For example, if the trust is funded with a $500,000 asset and earns a 7% return, the income will likely increase over time. By the end of the first year, the asset value may rise to $510,000, leading to a payout of $25,500 in the second year, demonstrating the potential for growth.
Key Considerations Before Setting Up a CRT
Before diving into the setup of a CRT, there are several key considerations:
1. Timing is Crucial
It’s essential to contact a financial advisor before listing or selling your property. The CRT must be funded with the asset before any sale is arranged. Once the property is in escrow, it’s too late to set up a CRT.
2. Debt on the Property
According to IRS rules, you cannot transfer property with existing debt into a CRT. If there is debt, it must be paid off before the transfer, either through cash or refinancing.
3. Types of Assets That Can Be Used
While real estate is commonly used, other appreciated assets can also be transferred into a CRT. This includes:
- Stocks
- Cryptocurrency
- Antique automobiles
4. Minimum Contribution Amount
The typical minimum amount to set up a CRT is around $100,000, although most trusts are established with values between $250,000 and $500,000.
5. Choosing the Right Charity
The charity you choose must generally be a 501(c)(3) organization. However, you can also designate a private or family foundation, though this may affect the charitable deduction you receive.
Including Beneficiaries
Another common concern is whether setting up a CRT means disinheriting your children. While the assets will ultimately go to charity, you can structure the trust to include beneficiaries, such as your children, by specifying a term of years for distributions.
Nationwide Applicability
One of the great advantages of a CRT is that it is a federal tax vehicle, meaning it can be utilized in all states. Whether you live in New Jersey, Florida, Michigan, California, or Idaho, the CRT can serve as a viable exit strategy.
Steps to Establish a CRT
If you’re considering a CRT, here are some straightforward steps to follow:
- Contact a financial advisor to discuss your options.
- Hire an attorney to draft a CRT agreement, as this is crucial for legal compliance.
- Transfer the property into the CRT.
- Once the property is sold, the proceeds should be invested in a balanced portfolio.
Tax Implications of CRT Income
It’s important to note that income received from a CRT is taxable. However, much of this income is typically taxed at the lower capital gains rate rather than ordinary income rates, which can be beneficial for retirees relying on this income.
Contacting Lon Dufek
If you’re interested in exploring a CRT further, reach out to Lon Dufek at lon.dufek@gmail.com or call him at (503) 267-9702. He offers expert guidance on gift planning and CRTs.
As you navigate the complexities of exiting your real estate investments, a Charitable Remainder Trust can be a powerful tool for not only managing your assets but also supporting charities you care about. It’s essential to consult with your CPA and legal advisors to ensure that you’re making the best decision for your financial future. For more information, please visit 1031exchange.com or call Equity Advantage at 800-735-1031.
In closing, whether you choose a CRT or a 1031 Exchange, it’s crucial to understand your options fully. Don’t hesitate to reach out for expert advice tailored to your unique situation.
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