A real estate investor who expects to realize a ~$2 million capital gain could stand to earn an additional $5.5 million over his lifetime by using a Charitable Remainder Trust before he sells them.
In this post, we’ll use a real life example to explain how Charitable Remainder Unitrusts, also known as CRUTs can be used to sell real estate, how it works and to help illustrate the benefits and the tradeoffs of CRUTs.
Case Study
Michael, who lives in Upstate New York bought an apartment in 2015 for around $250,000 and his investment is now worth about $2.25 million, and, although it’s been a good ride, he’s looking to diversify.
If he just sells his real estate without doing any tax planning, Michael will owe the federal government about $480,000 in taxes on his capital gains, and he’ll owe New York (city and state) another $270,000, for a total tax bill of around $750,000. Michael would rather not send more than 35% of his gains to the government immediately, who would?, so he’s looking into a Charitable Remainder Trust or CRUT.
Charitable Remainder Unitrust (CRUT) Overview
Recall that a CRT is a tax-exempt, irrevocable trust designed to reduce individuals’ taxable income. It distributes income to the trust beneficiaries at least annually for a specified period and, when that period is over, donates the remainder, everything that hasn’t been distributed yet, to your chosen charity.
A charitable remainder trust is the best of all worlds: It allows you to stash your assets in the trust, receive an up-front tax deduction, defer your taxes on any gains you realize inside the trust (for example, when you sell appreciated assets), put the trust’s income to use for yourself, and then donate a portion of the assets to charity at the end of the trust’s term.
Recapping the Numbers
Cost basis on real estate to be sold: $250,000
Current value: $2,250,000
Immediate Charitable Deduction
The first benefit Michael will receive from putting his real estate into a CRUT is an immediate tax deduction. There’s some complicated IRS-mandated math here, but the end result is actually straightforward: Michael will get to deduct about 10% of the current value of the assets he puts into the trust. In this case, that’s a $225,000 deduction. Since he lives in a high-tax city in a high-tax state, the tax savings are substantial: That $225,000 deduction translates into cash savings of about $90,000 on this year’s taxes.
No Taxes On Sale
So Michael starts about $90,000 ahead. The biggest benefit of a CRUT, though, is that he gets to defer all of the taxes, state and federal, he would otherwise have owed on his big sale. Instead of paying that $750,000 in taxes we calculated above, he’d get to keep that money and invest it.
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Available Withdrawals
There’s one more significant question Michael has to ask himself: How much liquidity does he need, and when?
One of the first questions we get in most conversations with our users is the following: “The returns are nice, but what if I need liquidity?” The answer is that CRUTs are more flexible than you think–in many ways, but especially in terms of liquidity options.
First, and most simply, due to the structure of CRUTs, Michael will have access to a growing share of his money every year, starting as soon as he sells his real estate: Every year after he sells, he’ll be able to cash out a set percentage of the trust’s current value (for a term trust, it’ll be around 11%; for a lifetime trust, it depends on his age, but it’ll be right around 6%). If Michael chooses a lifetime trust, and assuming that his trust’s assets grow at a historically average rate, he’ll be able to pull out about $2.24 million, strikingly close to the full starting value of his trust, after just 10 years. And if he chooses a term trust, he’ll be able to pull out even more if he wants to.
Aside from that simple liquidity calculation, moreover, Michael has other tools at his disposal. One easy option is to open a simple line of credit: Although he can’t borrow against the value of his CRUT, since part of that value belongs to his chosen charity, he can open a line of credit using the future income from his CRUT as collateral. What this means in practice is that Michael can access as much as the full value of his expected payouts from the trust at a reasonable interest rate, should he need more than the liquidity he would normally be able to take out of his trust.
What would all of these tax savings and investment gains mean for Michael’s bottom line? After, say, 40 years, if Michael has his money in a Charitable Remainder Trust, he’ll end up with about $20 million in total payouts. He’d ultimately pay about $7.3 million of that in taxes, so he ends up with about $12.7 million in his pocket.
Lastly, he’d also get to make a sizable donation to charity, to the tune of $3.8 million. This is the tradeoff of why the government is willing to let him grow his money tax-free.
If, instead, Michael had kept his money in a regular, taxable investment account, he would have instead ended up with about $10.5 million before taxes or $7 million after taxes.
In other words, even after donating a decent chunk of change to charity, Michael still pockets around an extra $5.7 million by putting his real estate into a CRUT right before he sells it.
Next Steps
Want to know more about real estate CRTs strategies? Check out Charitable Remainder Trust Real Estate Guide. Get started at no cost and no commitment. And if you have any questions, contact us through our chat button below, or schedule a meeting with us.
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