Putting real estate and other assets out as “gifts” might be intimidating and challenging for both taxpayers and charitable institutions. There is an associated technical complexity surrounding assets as “gifts.”
However, for real estate investors, it is essential to recognize the potential of charitable options as a viable exit strategy. By reducing the real estate taxes waiting for you, here are a few methods to help you save more for yourself.
Charitable Remainder Trust (CRT)
A charitable remainder trust (CRT) is also known as a split-interest vehicle because it generates two income streams. First is that, during its active lifespan, it pays a regular income to the donor who set up the trust or the named beneficiaries. It usually lasts for the entire lifetimes of the beneficiaries, with the payment coming from a percentage of the assets in the trust fund.
After the set period for the CRT, the remainder of the trust is then passed on to a charitable organization of the donor’s choice. It is a preferred financial strategy, especially for real estate investors, because of the income tax deduction it offers. The “remainder” interest intended for the charitable beneficiary is valued at present, which serves as the basis for the tax deduction. Furthermore, in the event that the deduction exceeds the charitable deduction ceiling, the qualified deduction can be carried over and deducted to the following years.
According to the Internal Revenue Service, qualified charitable contributions can be deducted from the adjusted gross income. For individuals, it can be up to 100% and up to 25% of the taxable income for a corporation.
Charitable remainder trusts can be further divided into Charitable Remainder Annuity Trusts (CRATS) or Charitable Remainder Unitrusts (CRUTs). Both function on essentially the same mechanics and offer the same tax deductions for individuals, and below are further explanations of what sets them apart.
Charitable Remainder Annuity Trusts (CRATs) vs. Charitable Remainder Unitrusts (CRUTs)
In a charitable remainder annuity trust or CRAT, the payment received by the donor or the beneficiaries is based on a predetermined percentage of the initial amount or the trust assets. Meanwhile, the payments for a charitable remainder unitrust (CRUT) come from a fixed rate of the value of trust assets, which fluctuates over time.
For example, you set up a 3% CRUT from a $100,000 initial amount or trust asset value. It will yield a fixed annual amount of $3,000. This payment value remains the same for the rest of the period or the beneficiary’s lifetime. At the end of the period, what remains from this fund goes to the designated charitable institution.
On the other hand, a similar 3% charitable remainder with an initial $100,000 also yields $3,000 for the first year. Should the value of the assets in the trust change for the next year and increase to, say, $200,000, then the next payment will be at $6,000. Similarly, if the trust value drops to $50,000, then the payment for the next year also drops to $1,500.
This setup means that with CRUTs, donors have the opportunity to receive increased payments with the increase of their trust asset values. However, it also carries the risk of diminishing payments. Generally, investments like cryptocurrency and real estate are invested in CRUTs, because of their growth over the years. Similarly, if you’re looking for a steady annual payment from your trust fund, CRAT is your option.
Flip Charitable Remainder Unitrust (Flip CRUT)
Another viable exit strategy for real estate investors is Flip CRUT, one of the types of Charitable Remainder Unitrusts but with a flip condition. CRUTs are divided into a Standard CRUT and a NIMCRUT, with a Flip CRUT being a hybrid between the first two. Basically, FLIP CRUTs start with a NIMCRUT arrangement before flipping into a standard CRUT.
In a practical setting, Flip CRUTs are designed to meet the donor’s evolving needs. For example, you’re a young professional with your real estate investments. With lower expenses, due to not having a family at this point in time, you understandable have a lower need for cash. Under these conditions, NIMCRUTs meet your needs better since you can defer withdrawals you don’t need, giving you better returns on your initial investment.
However, down the line, you might have a family or any other circumstance that will change your financial needs. If you’re looking for a steady revenue stream, a Standard CRUT can give you the extra income you need.
By having a Flip CRUT as your exit strategy for your real estate investments, you can defer payments as much as you want for the first years with a NIMCRUT arrangement and prepare your retirement fund later on as it transitions into a standard CRUT. Additionally, this combination of methods allows the taxpayer to use illiquid assets to fund a CRUT without letting go of the fractional interests before the sale. Therefore, it helps solve a liquidity issue that would otherwise be unsolvable with a NIMCRUT or a Standard CRUT alone.
Charitable remainder trusts are a great way to allow real estate investors to make a living, even after executing their exit strategies from actively dealing. By doing so, they keep more of their income for themselves through the different tax benefits that these trust funds offer.
Guest Blogger: Kat Sarmiento