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A Win-Win for Donors and Charity Using Depreciated Property

Posted February 2016

Many people who own rental property are not full-time investors in real estate and could wind up in a tax situation that can be solved by creating a charitable remainder trust.

They may have owned the property for many years and during that time have been depreciating it; the ability to deduct the depreciation has made ownership more attractive. However, they may reach a time when the property is nearly fully depreciated, and they want to be free of management responsibilities. If they sell the property, much of the proceeds will be capital gain, and the gain attributable to the depreciation can be taxed at a rate of 25 percent—or even 28.8 percent if their adjusted gross income is high enough to subject them to the Affordable Health Care surtax of 3.8 percent.

Capital-gain tax can be high
Here is an example of the problem: Many years ago Harry and Margaret, both aged 70, purchased a duplex for $150,000; it was recently appraised for $400,000. Taking into consideration $100,000 of depreciation, their current adjusted cost basis is $50,000. They are now retired and want to divest themselves of the property and move to a warmer climate. If they sell the duplex, they will pay capital-gain tax of $62,500 (25 percent of the $100,000 depreciation plus 15 percent of the remaining $250,000 of gain). The tax could be even more with the 3.8 percent surtax.

Charitable remainder trust provides income
The solution: Instead of selling the duplex, they transfer it to a charitable remainder unitrust that will pay them 6 percent of the value of trust assets each year. Assuming the trust sells the property and nets $400,000, Harry and Margaret’s income the first year will be $24,000.

They also receive an income-tax charitable deduction of approximately $139,000 that they spread over the next three years, significantly reducing their income tax. They are not taxed on the capital gain when they transfer the property to the trust, and the trust is not taxed on the gain when the property is sold. Their income will typically be a combination of ordinary income and capital gain.

Please contact us to discuss this and other planned giving options.

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