One of the first decisions tax- payers must make when planning their estates is what to do with the principal home. With the changing and sometimes downtrodden real estate market, this can be a difficult and time-consuming task for heirs, particularly if they do not reside in the same state and have no desire to keep or maintain the home. Homes can be on the market for months or sometimes years depending on their location, condition, and asking price. Often, heirs need to sell the home within nine months to provide the liquidity to pay estate taxes and any final costs associated with administering the estate. They may have to absorb a large reduction in the sales price to expedite the sale. One solution is to have the taxpayer gift a remainder interest in the home to a qualified Sec. 501(c)(3) charity. Benefits to the taxpayer include (1) an income tax benefit for the charitable deduction of the remainder interest; (2) the value of the home will be out of the taxable estate; (3) the taxpayer can continue to reside in the home for the rest of his or her life; and (4) the taxpayer will relieve the heirs of the burden of selling the home.
Gifting a remainder interest requires the property ownership to be divided into two separate interests: a life estate and a remainder interest. A life estate gives the holder the power to retain ownership until death. If the taxpayer is married, the life estate can be structured to last until the second spouse’s death. A remainder interest gives the holder the right to take ownership when the life estate has ended. The home will need to be appraised at the time of the gift to determine the value of both the life estate and the remainder interest. The IRS has published tables that are used to value the life interest in the property. The difference between the appraised value and the life interest is the remainder interest. This latter amount qualifies as a charitable deduction that the taxpayer could use to offset taxable income, subject to the limits for charitable contributions.
In determining the value of the charitable remainder interest for purposes of the deduction, straight-line depreciation is taken into account if the property is depreciable. However, for estate and gift tax purposes, the value of a charitable remainder interest is determined without taking depreciation into account. For a description and an example of how to determine the value of a charitable remainder interest in a personal residence for charitable deduction purposes, see Regs. Sec. 1.170A-12(b).
Only remainder interests in personal residences and farms are eligible under this provision (Sec. 170(f)(3)(B)(i)). A personal residence does not have to be the taxpayer’s principal residence to qualify, so the taxpayer can take a deduction for a vacation home. A farm is broadly defined to include any land used by the taxpayer or his or her tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock and the improvements on the land (Regs. Sec. 1.170-7(b)(4)).
The gifting of a remainder interest is not recommended on debt-encumbered property because it could result in undesirable tax consequences to both the donor and the charity. In this situation, possible solutions would be to transfer the debt to another property or to pay off any underlying mortgage prior to making the gift. Although ownership transfers at death, the donor is still responsible for paying the real estate taxes, property insurance, and maintenance expenses of the home during his or her lifetime.
This type of planning is especially beneficial for an individual with multiple properties who wishes to make a substantial lifetime charitable donation. It enables the individual to provide a home for his or her spouse or beneficiaries in the form of a life interest. When the life interest terminates, the property goes directly to the charity that received the remainder interest. This relieves both the donor and his or her beneficiaries of the burden of selling the property and paying any capital gain or estate taxes.
Increasingly, universities are benefiting from gifts of a remainder interest in houses and land. The university typically sells the donated property in order to support its programs and initiatives. Conservation groups such as public or private land trusts are another type of recipient of remainder interests when the donor is gifting farmland or property near a river or lake. Clearly, gifting with a remainder interest can be tailored to suit many types of individual needs while reaping tax benefits and fulfilling philanthropic interests.