GREG ROBERTS’ ON THE MONEY: The Charitable Life Estate
In the realm of estate planning, there are a myriad of tools available to the planner to facilitate the transfer of property to children and grandchildren, not to mention techniques to reduce the size of a person’s estate, and, thus, mitigate the potential bite of estate taxes. Additionally, and very importantly, avoiding probate is often a key consideration in the construction and implementation of any financial plan.
A long-standing technique of estate planning is a life estate, which is a type of joint ownership of property, usually land. A life estate is created by a deed that gives the property to an individual for the remainder his/her life, and this person is known as the life tenant. At the death of the life tenant, the property would pass to a person or entity owning the remainder interest, or the estate tenant. For example, a deed stating that land would go “to John Smith for life, then to Jane Smith” would provide John with a valid life estate, and Jane a remainder, or estate interest. John could use the land during his lifetime, and even sell his interest to a third party, but that third party would have to surrender the property to Jane upon John’s death.
A Charitable Life Estate is an agreement between a donor and a charity, involving usually either a residence or farm. The donor gives the property to a charity but retains the right to live in the residence or farm, typically, until death. Making a gift in this manner has several advantages. If a person has a charitable inclination, the utilization of the family residence can afford an elegant, yet simple solution to fulfill that charitable desire. Additionally, since the residence is not income-generating, the donor would not experience any diminution in lifestyle.
Another huge advantage of the Charitable Life Estate arrangement is that it generates an immediate and often substantial income tax benefit. Since there is a completed gift to a 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).
Using a simple example, if a couple, ages 75 and 78, were to retain a life interest in their residence, valued at $500,000, and make a gift of the remainder interest to their favorite charity, the current charitable deduction would be based on their joint life expectancy of about 17 years (at least one of the individuals would be expected to survive for this period of time), and the current IRS interest rate of 1.09 percent. The present value of the gift would be upwards of $415,000, and would provide sizeable income tax deductions for several years.
A third advantage of such a charitable life estate is that the residence would be removed from the taxable estate of the donor, and, depending on the value of the residence and the size of the rest of the estate, this removal could be important. Even if estate taxes are not of concern, having the family residence avoid probate can be huge, since the heirs and assigns would have one less thing to deal with when the couple has passed. For those settling the estate, this removal is often a very valuable benefit, since dealing with the disposition of a home is often cumbersome. The real estate market could be depressed, or the residence could be in poor condition, or there could be any number of other complications that are easily avoided with the use of a charitable life estate gift.
Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.