Charitable Remainder Trust & Honolulu Real Estate

February 6th, 2009 categories: For Sellers

When a rental property has been owned for an extended period, especially in Honolulu, it has probably appreciated an incredible amount. For many, this property may represent a major portion of their investment portfolio. The sale of this type of property could be a significant tax event! If a property were purchased 40 years ago, the owner may have paid a $100,000 for it and it could be worth $1,200,00 today. It is safe to assume that the entire $1,200,000 could be exposed to a combined Federal and State capital gains tax of 22.25%. This means an outright sale without prior planning could require a seller to pay a tax of $267,000! What options are available to a seller?

A 1031 Tax Deferred Exchange
In this scenario, a seller sells and then purchases another property of equal or greater value within prescribed time frames. When completed properly, a 1031 can defer the capital gains tax. A few challenges could come from this plan.
1. At a time when a seller is looking to manage less, a replacement property will probably be larger than the one just sold and this means it may require more management.
2. Because 1031 requires an exchange property to be of equal or greater value, it is probable that a seller will need to add additional cash or obtain a new mortgage to complete the sale.
3. Because of the higher acquisition cost, expect to pay more towards property taxes.
4. In order to significantly upgrade from an older property to a newer one, the acquisition cost may be significantly higher. This higher cost will eat up increases in cash flow.

A Charitable Remainder Trust (CRT)
In order for this to work, the owner of a property must be charitably inclined. Here is how it works.
1. The seller arranges a Charitable Remainder Trust (CRT) with a charity of their choice.
2. Their property is deeded to the CRT. The CRT is administered by the charity.
3. The property is then listed for sale and upon closing the sale, the funds are then put back into the CRT.
4. The CRT then arranges to have the funds invested with an investment advisor (this could be the sellers own investment advisor).
5. The CRT then pays the seller a monthly income of at a rate between 5% to 7% per annum (the is percentage is calculated based upon the principle in the trust). As an example, if the trust is funded with $1,200,000 and the payout to the seller is 5%, then the seller will receive $60,000 a year, which amounts to $5,000 a month.
6. The seller should receive a significant tax deduction too. ANYONE CONSIDERING A CRT MUST SEEK PROFESSIONAL LEGAL AND TAX GUIDANCE CONCERNING THE CRT ARRANGEMENT AND APPLICABLITY TO THEIR UNIQUE SITUATION.

Any sort of trust can be very complicated and therefore a significant amount of planning and consideration must be put into its formation. If you would like to speak with me about your unique situation, feel free to call me at 808-737-2093 or toll free at 877-737-2093.

This entry was posted on Friday, February 6th, 2009 at 4:00 pm and is filed under For Sellers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.