ELITE ADVISOR BEST PRACTICES

Charitable Life Estate - Part One

Donating one’s primary residence to charity can provide significant tax advantages and minimize family discord

By Randy Fox

Key Takeaways:

  • A charitable life estate is a tax-advantaged way for donors to give their homes or farms to charity but still live on the property until death.
  • Purchasing a life insurance policy within an irrevocable life insurance trust may help convince children that their parents did not “give away” their inheritance.
  • With so many children living far from their aging parents today, retirees shouldn’t assume children want to inherit their residences, no matter how valuable or desirable their residence is.


Contemplating an estate plan is a little bit like trying to construct a jigsaw puzzle: The clearer the picture you have of the desired outcome, the easier it is to construct. Often, a piece of the puzzle that is overlooked is the family’s principal residence. Many parents mistakenly believe that their children will “want the home.”

In today’s environment, it’s more likely that the family is geographically dispersed and the children would much rather receive the value of the home and its important and memorable contents, rather than the house itself. If the older generation is somewhat charitable, an interesting, simple and often overlooked strategy is the use of a charitable life estate (CLE).

When life insurance meets real estate

Purchasing a life insurance policy within an irrevocable life insurance trust that’s based on the current or future value of the home may satisfy the children that their parents did not “give away” their inheritance. This article will discuss some of the advantages as well as some of the necessary precautions when considering a charitable life estate as a planning element.

A charitable life estate is a gift agreement between a donor and a charity, in which the donor gifts their residence (or farm) to charity but retains the right to live in the property, usually until death.

This type of arrangement has several advantages for the donor:

  1. First, and most important, it may satisfy a desired charitable intent. Most gifts are still made by bequest and utilizing the family residence may afford a simple solution to fulfill that need. Homes aren’t income producing and, in fact, donors won’t notice any change in their lifestyle based on the gift.

  2. Second, the charitable life estate arrangement provides an immediate income tax benefit. Since there is a completed gift to 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 computation is somewhat complex, and there are many software packages on the market that can help you. Of course, the residence must be professionally appraised to determine the current fair market value before the computation is made. Having the benefit of a charitable income tax deduction may allow the donor to time other transactions better, such as the sale of appreciated securities. For instance, the deduction may offset the impact of a large capital gain. Furthermore, like other charitable deductions, any unused amount from the CLE may be carried forward for an additional five years.

  3. Third, the residence is removed from the taxable estate of the donor, so it’s one less issue for the estate to deal with. For those settling the estate, a CLE is often a very fortunate event. Dealing with the disposition of a home is often quite cumbersome. The real estate market could be depressed, the home could be in poor condition and in need of repair, or there could be any number of other complications that are easily avoided with the CLE arrangement.

Real-life case study

John and Edna are 78 and 76 years old, respectively. The married couple’s home is valued by a qualified appraiser at $420,000, of which the land is worth $60,000. Only the value of the home itself is used to calculate the gift.

A gift of their home to charity with a retained life estate for the lives of both spouses will produce a current income tax charitable deduction of approximately $178,000. Even if John and Edna are in the 30 percent tax bracket, the gift could save them $53,900 in income taxes. A life estate is completed by executing and recording a deed. Unlike many charitable planning tools, a life estate is a relatively simple transaction for the donors. Meanwhile, they will retain the right to live in the house as long as either of them is alive. They will continue to pay all the costs of maintenance, real estate taxes, utilities and insurance just as they had in the past.

Precautions

Of course, there are some additional considerations to keep in mind. John and/or Edna could become incapable of living on their own and may need to vacate the home. What happens then? There are several possibilities to consider: They could sell the home and give the charity its portion (the remainder value) and keep the life interest portion; they could accelerate their gift by giving their life interest to the named charity and receive an additional income tax deduction; they could rent it to a third party; or they could exchange their life interest with the charity in exchange for a gift annuity income stream.

In a future article we’ll discuss many of the technical aspects of charitable life estates, and look closer at potential applications of this type of gift. Meanwhile, it’s clear that this type of gift is both powerful and useful for the appropriate family. It is up to the planner to open the discussion with the client family and to demonstrate the potential of this planning strategy.


About the Author

Randy Fox is Editor in Chief of Planned Giving Design Center and is the regional representative of Charitable Giving Resource Center.