Charitable Alchemy: Something from nothing (or almost nothing) or Getting paid to live in your house for the rest of your life

Bryan Clontz, PhD, CFP®, CLU®, ChFC®, CAP®, AEP®, RICP®, CBP

Charitable Solutions, LLC

Randy Fox, CFP®, AEP®

Two Hawks Consulting, LLC

Combining two split interest gift types into a single transaction isn’t easy. In fact, most practitioners aren’t aware that this idea is even achievable. This paper will describe the combination of a retained life estate and a charitable gift annuity. We will examine the structure, review the ideal circumstances for utilizing this strategy and illustrate the risks that are associated with the implementation of such a gift.

Practitioners familiar with charitable planning strategies are aware of the benefits of donating a remainder interest in a residence. The charitable life estate is a split interest gift whereby the donor(s) donate a residence to charity but retain the right to live in it for their lives. There are several reasons why donor(s) would enter into this arrangement:

1. A desire to make a testamentary gift of real estate coupled with a need or desire for a current income tax deduction, perhaps to offset other taxable income;
2. A desire to avoid probate;
3. A donor without heirs who desires to leave assets to a charity at death;
4. A donor who desires to make a significant gift but does not want to jeopardize their  financial well being by gifting financial assets;
5. A donor whose heirs “don’t want the residence”.

Further, the charitable gift annuity (CGA) is familiar to most charitable planners. CGAs are an instrument issued by a charity that pay a regular income to one or two donors for their lifetimes. CGAs are most often funded with cash or marketable securities and, occasionally with real estate. A donor is entitled to a charitable income tax deduction based on the remainder that  passes to charity at the date of the gift. There are many reasons why donor(s) may choose to donate assets in exchange for a CGA including:

1. The desire for a steady and predictable income;
2. A desire to avoid long term capital gains taxes by funding the CGA with low basis assets;
3. A desire to leave assets to charity without jeopardizing their current financial security
4. A desire to obtain a charitable income tax deduction;
5. A desire to remain in their home while supplementing their income.

While both split interest gifts are common and used quite frequently the idea of pairing them is less common. The transaction requires two distinct steps. First, the donor must complete a life estate agreement with the charity. The agreement must comply with the basic tenets of a life estate agreement: 1. It must be a residence; 2. It must not be a gift in trust; 3. It must be irrevocable; 4. It must be a remainder in the property itself. At the time the gift is completed, the donor has a life estate and a charitable income tax deduction, which is the actuarial value the charity is expected to receive at the donor’s death. Second, since the remainder (or “tax deduction”) has a calculated value, the donor can negotiate with the charity to exchange it (which the charity is going to ultimately receive) for a benefit. That benefit is a CGA. Of course, the charity must be authorized to issue CGAs under state law and must be willing to assume the risks associated with issuing the CGA. Some of these are:

1. A decline in value or a failure by the charity to realize the full value of the property
2. The annuitant may live beyond their projected lifespan, requiring an extended period of payments
3. The property may remain vacant for an extended period of time causing the charity to pay utilities, taxes and other carrying costs.
4. The payment of the annuity distributions out of their own capital which may  negatively impact their reserves (this may be the biggest challenge for organizations considering this offering).

One way for the charity to mitigate the risk is to offer a lower annuity rate than they would for a gift of a liquid asset such as cash or marketable securities. Similarly, they may simply calculate the annuity based on a lower remainder interest amount.           

An Example Gift Below:

The donor is 87 years old (typically this gift works best for older donors) and the property is valued at close to $1 million in an affluent area of California.

• The $1 million property was logically split into a $750,000 remainder interest and $250,000 as the value of the donor’s life interest.

• The $750,000 remainder interest was used to “fund” the annuity.

• The alignment of the donor’s age and the value of the annuity came together to suggest a favorable combination for the annuity calculation.

• The donor will receive an annual payment of $65,000 and will be responsible for the expenses of the property until her passing, such as taxes, insurance, upkeep etc. (common in RLE arrangements).

• The donor’s tax benefits on the RLE gift separate from the tax benefits from the annuity were a challenge

•  It worked out nicely for the donor. The donor has named 5 charities to be the beneficiaries of the final proceeds of the sale of the property.

Our reference work Charitable Gifts of Noncash Assets (2^nd ed, October 2018) is a good companion for those curious about illiquid asset gifts. The use of  charitable annuities funded by real estate  is one of twelve assets discussed in a new appendix. Other sections have been updated, including recent insights into virtual currency issues and opportunities. The book also offers a broad introduction to illiquid assets, terms and conditions which should to be part of the gift acceptance procedure, insights into donor conversations, as well as estate settlement issues.

Charitable Gifts of Noncash Assets is available as a free download at our website www.charitablesolutionsllc.com or from Amazon.com in print format. We appreciate your interest in these types of gifts and – give us a call, we are very willing to help you and your team with inquiries at any time.