Case: Rhea Jones, 75, lives in a beautiful coastal town in northern California.
Rhea's home occupies three magnificent acres of bluff property that
overlooks the crashing waves of the Pacific. Since her home sits just
steps away from the dramatic cliffs, Rhea frequently jokes to her friends
about her "living on the edge" lifestyle.
John, Rhea's husband of 50 years, built the custom home ten years
ago. It was truly the realization of a lifelong dream of John and Rhea.
Unfortunately, John passed away unexpectedly five years ago. Now, Rhea
lives alone in the large home. Nevertheless, Rhea is looking forward to
spending her remaining days in this lovely home. Not surprisingly, she
frequently plays host to her children, grandchildren and friends.
Rhea is an active philanthropist. In fact, she spends three days a week
volunteering with local charities. While very wealthy and philanthropic,
Rhea makes only modest yearly gifts. However, she intends to make a substantial
bequest upon her death. Specifically, Rhea plans on distributing her entire
estate to her children and grandchildren, except for her cliff-side home.
Rhea's will provides that the home passes to John and Rhea's favorite
charity upon her death. The home is worth $3 million.
However, at a recent estate planning presentation, Rhea discovered the
benefits of a gift of a remainder interest in a personal residence. In
particular, she liked the potential significant tax savings and the home's
avoidance of the probate process. Also, because the gift is irrevocable,
the local charity would recognize and honor Rhea for her generous gift
at the annual fund raising gala. Of course, Rhea would retain the right
to live in her home for the rest of her life, which is an absolute requirement
to any potential gift arrangement.
Question: Rhea is very excited about this gift arrangement, but she has many questions.
Before she commits to the gift plan, she wants to address several issues.
In particular, Rhea learns that now is an excellent time for gifts of
remainder interests in a home. Why is this so?
Solution: A gift of a remainder interest in a home produces a charitable income
tax deduction equal to the actuarial value of the remainder interest.
When computing the remainder interest value, an applicable federal rate
(AFR) must be used. With each gift, a donor may select from three available
AFRs – the current month's AFR, the previous month's AFR
or the second previous month's AFR. For gifts of remainder interests
in a personal residence, the lowest available AFR produces the largest
charitable income tax deduction. This means timing and planning may provide
a tax opportunity for Rhea.
At the time of Rhea's proposed gift, the AFR is at a low level. Thus,
it is a great time to complete a gift of a remainder interest in a home.
For instance, Rhea's charitable deduction is approximately $1.9 million
when using a 4.0% AFR. However, if Rhea gifts her home when the AFR is
2.2%, her deduction increases to over $2.2 million. Therefore, an additional
tax deduction may result in excellent tax savings!
Although retired, Rhea still receives significant income each year from
her IRA, John's pension plan and her income producing investments.
Moreover, she plans on selling several million dollar investment properties
during the next several years, because she no longer wants the hassle
and management associated with them. This will undoubtedly result in substantial
capital gains tax. As a result, she will have six and seven figure taxable
income to report over the next several years.
With a large $2.2 million charitable income tax deduction, Rhea will greatly
and effectively reduce her future income tax liability over the next six
years (current year plus five additional years). Consequently, Rhea continues
the gift planning process with unbridled enthusiasm.
Living on the Edge, Part 1
George's "UT to Green Gift Annuity" Conversion