The MacRo Report Real Estate Blog is pleased to introduce our newest guest writer Bruce Bigelow, Senior Partner at Charitable Development Consulting
How often have capital gains taxes prevented a sale of real property? For real estate professionals, whose job it is to put together a willing buyer and a willing seller and to structure a sale transaction that benefits both, sometimes those pesky taxes due on the sale stop an otherwise satisfying sale from going to closure.
Partnering with charity can sometimes be the answer and provide a benefit to seller and buyer alike, while allowing the broker to bring the two parties together to everyone’s satisfaction. Let’s look at how this might work.
Sam Smith has raised soybeans for thirty years on his 100 acre farm, which he purchased in 1980 for $250,000. In the intervening decades, however, the urban center that was five miles away in 1980 has grown, and Sam’s farm is now situated right next to a thriving housing development and has been designated in the latest county master plan for possible rezoning. Sam and his wife Sara are both now 70, and those sunrise tractor tours of his fields are getting old.
Fortunately for Sam and Sara, an enterprising and knowledgeable real estate broker (let’s say, MacRo Ltd., as an example) approaches him with an opportunity. A Baltimore developer is looking to move into the Frederick County market and has recently sold a property in Baltimore County under a 1031 exchange rule. The developer has cash he needs to spend in relatively short order, and Sam’s farm seems like just the right possibility.
The developer is prepared to pay Sam $5 million for his land and Sam sees this as a way of ensuring a solid cash flow for himself and his wife for the remainder of their lives. But then Sam realizes he will owe a whopping capital gains tax as soon as he sells the farm–$637,500, to be exact (15% of the gain–$4,750,000 minus the $500,000 exemption because the farm is their primary residence). If capital gains taxes go up in the future, that bite could grow to $850,000.
The deal looks dead. But MacRo Ltd. knows better. Sam and Sara are quite charitable and have several small non-profits they regularly support. They would love to do more for them than their cash flow allows. Now Sam and Sara can do it all: secure a lifetime income stream, avoid all of the capital gains tax, and make a long-term gift to the charities they care about, all in the same transaction.
Here is how it works. Sam and Sara place the property into a Charitable Remainder Unitrust with the trust department of his local bank as the trustee. Sam and his wife start receiving income only after the property sells; until then the trust is not obligated to pay income it does not have. But, since there is a potential buyer already identified, the sale might be only a short time coming. When it does, Sam and his wife begin receiving 5% of the full $5 million, or $250,000 per year.
With the trust being tax-exempt, it is likely to grow over time as well, and that $250,000 annual income could well grow proportionally. Not only does Sam avoid all the capital gains tax; Sam and Sara’s up front income tax deduction of over $2 million will offset a significant portion of their taxable income for the next six years.
In the end, after Sam and Sara’s lifetimes, the trust will distribute the principle to the charities they have designated. The deal goes through. MacRo Ltd. has done its job (and receives the commission it has rightly earned). Sam and Sara are ecstatic. The charities are thrilled. The developer is satisfied. And a transaction that was in jeopardy is threatened no longer.
Charitable real estate transactions come in many forms. Sam’s is just one. Such transactions require a careful and thoughtful process of vetting and examination. Most often a professional real estate broker and a professional charitable planned giving expert, in combination with the property owner’s financial and legal advisors, are the team that can put these transactions together successfully.
Real estate transfers can be complicated, but the benefits to everyone involved are so great that charitable partnerships should be part of every real estate professional’s set of options.
Bruce Bigelow is Senior Partner at Charitable Development Consulting, which provides a wide range of services to non-profits around the country, ranging from training board how to ask for gifts to detailed conversations with major donors and their advisors about complicated estate transactions. Prior to founding this business, Bruce was Vice President of Institutional Advancement at Hood College in Frederick, Maryland.