Case Study: How to spot a prime CRT opportunity

Imagine that a client sits down at your conference room table and begins the meeting something like this: “I’ve got a prime tract of land I bought for $200,000 just 10 years ago, and now I am sure I could sell it for $2 million because the market is so hot for new residential development in the area. I need to act fast because I am not sure how much longer this real estate boom will last.”

What’s your response? Before you suggest that your client put the property up for sale as soon as possible, consider asking a few more questions that could save your client a lot of money and help satisfy the client’s income and charitable giving goals at the same time.

“That’s fantastic,” you say. Instead of jumping to getting the property listed, you go deeper.

“Your current estate plan already includes bequests to hospice, animal rescue, and the art museum,” you remind the client. “There actually is a way to wrap those goals into your strategy for selling the land.”

“Hmmm,” the client says, considering your idea. “If it’s all the same in terms of which charities receive money when I die, sure, I’m open to it.”

“Good,” you respond. “Now, remind me, does this property produce any income for you right now?”

“Unfortunately, no,” replies your client. “I’ve never had time to develop the land, so it just sits there. At least the value has been going up.”

“Ah,” you respond. “With the technique I have in mind, you may be able to secure an income stream for the rest of your life, in addition to satisfying your charitable goals and capitalizing on the property’s high value.”

“That sounds great,” is your client’s response, which you predicted.

So what idea is on your mind for this client? Hint: Its initials are C-R-T.

That’s right. CRT. A charitable remainder trust (“CRT”) is a “split-interest” charitable planning tool that allows your client to transfer an asset (in this case, real estate) to an irrevocable trust, retain an income stream, and earmark what’s left (the “remainder”) to pass to a charity or charities of the client’s choice.

For example, in our hypothetical situation, your client could establish a fund at the community foundation to receive the CRT’s assets following the termination of the income stream, in this case, on the client’s death. The client’s fund at Cobb Community Foundation can provide for distribution of those assets to hospice, animal rescue, and the art museum according to the client’s wishes.

Because the charitable remainder trust qualifies as a charitable entity under the Internal Revenue Code, here’s what happens from a tax perspective:

  • When the client transfers the property to the CRT at a fair market value of $2 million with a cost basis of $200,000, and then the CRT sells the property, the CRT itself does not pay tax on the $1.8 million capital gain.
  • This leaves the full $2 million in the trust to be invested, subject to the client’s retained income stream.
  • The client is eligible for a charitable tax deduction of the fair market value of the property given to the trust, minus the present value of the retained income stream.
  • Payments to the client generally are subject to income tax during each year of the distributions, but under more favorable terms than if the client had conducted an outright sale.
  • Because the CRT is an irrevocable trust, the property and its proceeds (other than what winds up in the client’s estate from the retained income stream) are excluded from the client’s estate for estate tax purposes.

Contrast this with an alternative scenario in which your client sells the property, realizes a $1.8 million capital gain, pays tax on that gain, and ends up with, say, $1.5 million (probably less!) with which to invest, give to charity, and draw from for income. And, in this situation, the proceeds would be included in the client’s estate for estate tax purposes. Ouch!

When you spot a client who could benefit from a CRT, give us a call! The team at Cobb Community Foundation is happy to help you as you serve your clients from the moment a client walks in the door through fulfilling the client’s wishes after the client passes away.