Remainder interests in homes and farms

Charitable Gifts of Homes & Farms with

Retained Life Estates

Russell James, J.D., Ph.D., CFP®Professor, Texas Tech University


Retained Life Estates 1. Introduction

A partial interest gift with retained

interests occurs when a donor

gives some rights to

property but keeps others

Normally, donor can’t keep some rights and deduct a partial interest gift

But, you can deduct a remainder interest in a home or farmland even when retaining a life estateOther Exceptions• Giving all or an

“undivided portion” of a property interest

• Charitable remainder/ lead trust or pooled income fund

• Qualified conservation easement

A remainder interest gives the right to own the property after a set time or after the death of a

person

Unlike a will, a remainder interest is not revocable, and can even be sold

Remainder Interest

A deductible remainder interest in farmland or a personal residence must be transferred by deed, not by trust or contract

A farm is any land and improvements used (even by a tenant) to raise crops or livestock

A remainder interest in any part of a farm may be gifted

(Rev. Rul. 78-303)

Can I give a remainder interest of an undivided share in

farmland?

12.5%

25%

Yes, donor may deduct a remainder interest shared by

charity and others as tenants in common (Rev. Rule 87-37)

12.5%

25%

• No deduction for remainder just in mineral rights because it is not a “farm” Reg. 1.170A-7(b)(4)

• Can gift remainder in entire “fee simple” farm (even if land and mineral rights go to separate charities) PLR 8316037

• Can gift remainder in farm without mineral rights if you don’t owned them

Mineral Rights


Retained Life Estates 1. Introduction


Retained Life Estates 2. Calculating the deduction

for farmland

How do you calculate the deduction for a remainder interest in farmland?

1. Find the §7520 interest rate https://www.irs.gov/businesses/small-businesses-self-employed/section-7520-interest-rates

2. Multiply value of land by remainder percentage for that interest rate (from IRS Pub. 1457 for one or two lives or specific term)

https://www.irs.gov/retirement-plans/actuarial-tables

Ex: A remainder interest in $100,000 of farmland given by a 59 year old donor on 1/31/17


Choose current or one of last

two month’s rate

Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2016 1.61 1.6 Rev. Rul.

2016-26December

2016 1.76 1.8 Rev. Rul. 2016-27

January 2017 2.36 2.4 Rev. Rul.

2017-2

Nov 1.6%Dec 1.8%Jan 2.4%

Charitable Deduction

Charitable deduction for remainder interest deed with retained life estate in $1,000,000 of farmland by age 59 donor

1.0% (Jan 13)

$804,79011.6% (May 89)

$156,840



Section 7520 Interest Rates

Valuation Month

120% of Applicable Federal Midterm Rate

Section 7520 Interest Rate

Revenue Ruling

November 2016 1.61 1.6 Rev. Rul.

2016-26December

2016 1.76 1.8 Rev. Rul. 2016-27

January 2017 2.36 2.4 Rev. Rul.

2017-2

Nov 1.6%Dec 1.8%Jan 2.4%

Choosing the lowest rate creates the highest deduction, so here we select 1.6%

2. Multiply value of land by remainder percentage for that interest rate

https://www.irs.gov/retirement-plans/actuarial-tables


Because here the remainder goes to charity after a single life, download Table S. For two lives use table R(2) instead


Table S - Based on Life Table 2000CMInterest at 1.6 Percent

Life LifeAge Annuity Estate Remainder Age Annuity Estate Remainder0 43.2834 0.69253 0.30747 55 20.2512 0.32402 0.675981 43.2802 0.69248 0.30752 56 19.7091 0.31535 0.684652 42.9946 0.68791 0.31209 57 19.1677 0.30668 0.693323 42.6968 0.68315 0.31685 58 18.6279 0.29805 0.701954 42.3908 0.67825 0.32175 59 18.0893 0.28943 0.71057

Scroll down to the part of the table for the selected §7520 rate (1.6%)

Find the remainder percentage for the age of the donor (59)

Remainder %X Farmland value

Deduction


.71057X $100,000

$71,057



for farmland


Retained Life Estates 3. Advanced planning

strategies

Leaving land to charityby will

•Revocable•$0 tax deduction• Impacts charity after

death

Leaving land to charity

by remainder deed

• Irrevocable•$71,057 immediate

income tax deduction• Impacts charity after

death or immediately if charity sells remainder interest• Immediately increases

cash assets available for income producing investments

Because farmland can be gifted in parts, a donor could annually give remainder interest shares up to income limits or desired marginal tax rate

•Allows for increasing valuation each year

•Avoids risk of losing carryover deduction at death

•Could use value of annual deductions to pay for ILIT life insurance passing tax free to heirs

Donor can use money from remainder gift tax deduction to buy tax free life insurance (ILIT) for children’s inheritance [aka “wealth replacement trust”]

remainder interest in farmland given to charity

$71,057 deduction x (39.6% fed + 5% state) = $31,691

$31,691 buys est. $70,000 paid up ILIT life insurance

children receive $70,000

(tax free from ILIT)

will divides farmland 10% to charity 90% to children

charity receives $12,500

(10% x $125,000)

children receive $67,500 (90% x 125,000 = 112,500, less 40% for estate taxes)

charity receives

$125,000 farmland

farmland worth $125,000 at death

Age 59 wealthy donor with $100,000 farmland

Gifts of a remainder interest with retained life estate in the donor’s personal residences can also be

deducted

Remainder Interest

Includes second homes, vacation homes, even a boat with bathroom, cooking, and sleeping facilities, if used by

the donor as a residence


Retained Life Estates 3. Advanced planning

strategies



for a home

Deduction for a remainder interest in a house is less than for

land because houses wear out

59 year old donor giving on 1/31/17Remainder interest in

$100,000 farm

.71057 x $100,000

$71,057 Deduction

.32720 is the Depreciation Reduction Factor

Remainder interest in $100,000 home

.71057 x $20,000 (land)

.71057 x $10,000 (salvage)(.71057-.32720)x $70,000

$48,153 Deduction

Depreciation reduction factor

R factor age – R factor age after useful life of houseD factor age X Useful life of house*

Table C at www.irs.gov/pub/irs-tege/table_c_2009.xls See IRS Pub. 1459 http://www.irs.gov/pub/irs-pdf/p1459.pdf

Ex: 59 year old donor giving on 1/31/17

R factor@59 – R factor@104 D factor@59 X 45

Table C(1.6)Factors for Reducing Assurances -

Based on Table 2000CMInterest at 1.6 Percent

Age R-Factors D-Factorsx Rx-0.5Mx Dx

59 510527.3 34667.69… … …104 77.95371 47.58894

510527.3–77.9537134667.69 X 45

=.32720

*An appraiser can estimate the useful life of a house. IRS examples use 45 years.

Underlying formula gives same result i.e., it equals remainder factor – depreciation reduction factor

n = the building’s estimated useful life, e.g. 45i = the 7520 interest rate, e.g. 0.02v = 1/(1+ the 7520 interest rate), e.g. 1/1.02x = the age of the life tenant, e.g., 59lx = expected number of persons living at age x out of 100,000 births as set forth in Table 2000CM (available for download at http://www.irs.gov/Retirement-Plans/Actuarial-Tables)

Present value of the future

amount in the middle of each

year

% chance of donor death in each year of

building’s remaining life

% of value remaining in the middle

of each year

http://www.irs.gov/Retirement-Plans/Actuarial-Tables

Formula required to calculate factor for the depreciable part for two lives

n = the building’s estimated useful life, e.g. 45i = the 7520 interest rate, e.g. 0.02V = 1/(1+ the 7520 interest rate), e.g. 1/1.02x & y = the ages of the life tenants, e.g., 59 & 62lx & ly = the number of persons living at ages x and y in Table 2000CM (http://www.irs.gov/Retirement-Plans/Actuarial-Tables)

Or, for an actual contribution,

you can ask the IRS to calculate

this for you

For a fixed term, just assume value of depreciable part

reduced by (term/useful life)

Ex: In 20 years house will be valued at $20,000 land + $10,000 salvage + $70,000 – [$70,000 x (20/45)], or $68,888.89.

Deduction is $68,888.89 X remainder value for 20 year term certain from table B https://www.irs.gov/retirement-plans/actuarial-tables



for a home


Retained Life Estates 5. Rules after the gift is

made

What if the donor leaves?

What if the donor leaves?

Agree with the charity to

a joint sale and divide proceeds

Give life estate to charity in

exchange for a gift annuity

Give life estate to charity

Rent property

Sell life estate

Will the donor maintain the

property?

Will the donor maintain the

property?

What if I make improvements to my residence after giving a remainder interest?

Can deduct the remainder value

of major improvements as additional

gifts PLR 9329017; PLR 8529014


Retained Life Estates 5. Rules after the gift is

made

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Retained Life Estates

Russell James, J.D., Ph.D., CFP®Professor, Texas Tech University

Economy & Finance

Remainder interests in homes and farms