A Life Estates Case Study

An advisor gets creative to help a client transfer wealth across generations, fund favorite charities and keep a family tradition alive

By Randy Fox

Key Takeaways:

  • For estate planners, a client’s vacation property can be especially tricky when family traditions and charitable intentions come into play.
  • Under some circumstances, a CLE can be a smarter way than a QPRT or a sale/leaseback to an intentionally defective trust to transfer a vacation property to future generations.
  • A dynasty trust is available in many states, and clients can select a favorable jurisdiction to meet their planning needs.

In November and January, I discussed the charitable life estate strategy as a potential solution for a family who is both charitable and has no particular desire to keep their home in the family. In many cases, especially when there is a vacation property that the family has enjoyed together, there is a strong desire to maintain that home for the succeeding generations. Is it still possible to utilize a CLE and keep the home in the family? The answer is yes, with some caveats.

A case story

Les and Ruth are 68 and 66 years old, respectively. Their three grown and married children and eight grandchildren are scattered around the country, but every year without fail they all gather at the family homestead, known as the RuthLes Ranch, to vacation together and to discuss important family matters. They lovingly call this the RuthLes Roundup. This event has become a sacred rite of the family, and the children would like to keep the property and the tradition alive after Les and Ruth are gone.

Les and Ruth have a taxable estate, with most of the wealth created by the sale of Les’ business. Further, they are very charitable, especially in their local community. RuthLes Ranch is part of their taxable estate and is currently valued at $1.68 million. While there are several strategies that might be contemplated to transfer the property to the children, none is particularly effective. Because of the low interest rate environment, a QPRT is unlikely to succeed. A sale/leaseback to an intentionally defective trust is possible but may cause unwanted scrutiny by the IRS. Neither of the aforementioned strategies satisfies any charitable desires either.

On the surface, a CLE seems NOT to work, since the RuthLes property will ultimately belong to the charitable remainder beneficiary. However, with some unusual thinking, this issue can be overcome. One very important point to remember is that the “gift” has a value and is truly an asset. In this case, Les and Ruth enter a life estate agreement with a favorite local charity. They receive an income tax charitable deduction of approximately $600,000, which will save them as much as $240,000 of income tax if they are in the 40 percent income tax bracket (combined federal and state). They have agreed to pay all of the upkeep, taxes and maintenance for the property. Simultaneously, Les and Ruth establish an irrevocable trust for the benefit of their children and grandchildren (and successive generations) and fund it with a gift of $100,000. This type of “dynasty” trust is available in many states, and certainly Les and Ruth can select a favorable jurisdiction to meet their planning goals.

Working the numbers

Three years later, the children approach the local charity and suggest that they (or the trust, actually) would be interested in purchasing the “remainder interest” that the charity owns. The charity will get the remainder interest valued by a qualified appraiser for an amount based on Les’ and Ruth’s current ages and the current value of the property. At this time, the remainder is valued at $720,000. The trust agrees to purchase the property for the appraised value and finances the balance of $620,000 at 3 percent for 10 years. Payments can be made by Les and Ruth’s making annual gifts to the trust. The charity now has cash in the bank and a cash flow stream secured by real estate. They’ve sold a property that they would have ultimately had to sell. The family trust, which could last for multiple generations, now owns the property outside Les’ and Ruth’s estates. While there can be no prearrangement of this transaction and no assurances that it will be completed in this manner, it is a win-win for all parties concerned.

Planners are often faced with unusual circumstances that require creativity in planning. This type of CLE strategy may be applicable only in the rarest of circumstances, but it is helpful to have the resources and knowledge in place when the time is right.

About the Author

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