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Maintenance, Taxes, & Security /
10/01/2006
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| [Homeowners] |
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| Considering charitable tax-deferral strategies when selling. |
| text by: |
Lark Ellen Gould |
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The fact that Uncle Sam charges roughly 15
percent capital gains tax on non-primary home sales (not to mention that state
income taxes increase from the sale as well) is a little daunting for those who own one or more vacation homes. In the
case of a couple with a $1.15 million second home, it means writing a $150,000
check to the government at the close of escrow.
One creative tax-deferral strategy available is the $500,000
capital gains exclusion for married couples, as provided in Section 121 of the
U.S. Tax Code (in the above example, the capital gains basis of the home would
be cut to $500,000, and the check to Uncle Sam would be reduced to a mere
$75,000). However, that exclusion will not apply unless the couple manages to
live in the home for two of the five years preceding the sale. If the home is a
recent rental, it could be years before they could sell it tax-free.
 Illustration by Michael Austin. (Click image to enlarge)
Seth Pearson, who runs Pearson Financial Services in Dennis,
Mass., presented his clients John and Joan Wheeler of Cape Cod, both age 65,
with another alternative. Pearson suggested deeding the home to a charitable
remainder trust (CRT), then plowing the saved wealth into a foundation to
benefit their heirs—or choosing a private annuity trust (PAT). The latter takes
the house proceeds and invests them in order to pay out a high-five-figure
annuity to the client each year. The fee for one of these plans is only $2,000,
but Pearson says it is well worth it.
Going in, the Wheelers also had a $1 million primary residence,
a $500,000 IRA and a $500,000 taxable portfolio of stocks, bonds and mutual
funds. They wound up deeding the house to a CRT that, based on an input of their
$3 million net worth, will, over time, pay out more than $6 million to nonprofit
activities of the family’s choice, allowing their five heirs—two children and
three grandchildren—to receive the equivalent of $5.3 million in tax-free
"stretch" IRA payments over the next 45 years.
However, tax attorney G. Scott Haislet, of Lafayette, Calif.,
cautions that clients need to be presented with two more choices: an IRC Section
1031 Exchange (requiring the vacation home to first qualify as an "investment")
or simply paying the taxes on the sale after all.
Haislet has particular qualms about PATs. "All aspects of a PAT
must be evaluated and projected; many times a realistic projection shows a PAT
to be a losing proposition," he says. "Advisers, especially investment brokers,
often ignore certain negative trust-tax implications or sugarcoat promised
investment returns. So clients must be very careful."
Haislet’s clients Bill and Julia Claire were in a position not
unlike the Wheelers. In their case, he advised a taxable sale. "Actually, at 15
percent federal plus state income taxes, taxes are ‘on sale’ now," he says.
"A key question I had insisted we answer was what investments Bill and Julia
would be making upon receiving the after-tax proceeds. Depending on a client’s
target investments, he or she may very well elect to revisit an IRC Section 1031
strategy to avoid tax."
A charitable strategy such as the Wheelers’, Haislet warns, is
not a clear shot for most pre-retirees seeking to sell. "Genuine donative intent
must exist—the donors will be giving away their heirs’ inheritance partially or
fully. In almost all cases, the donation will far exceed the tax savings, though
some life insurance strategies can mitigate this difference."
| Contact: |
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Seth Pearson
Pearson
Financial Services
800.385.7925
G. Scott
Haislet
925.283.1031
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