Take-Away: Now may be the perfect time for an individual to make a gift of a remainder interest in a home, cottage, or farm to a charity. Such a gift creates a charitable income tax deduction.

Background: An individual is entitled to claim an immediate income tax charitable deduction if a remainder interest in their home, cottage, or farm is given to a tax exempt charity. [IRC 170(f)(3)(b).] The gift is made through a deed. The individual is entitled to live in the home, cottage, or farm for the balance of their lifetime. On their death, the charity records their death certificate with the register of deeds. Thus, the home, cottage, or farm avoids probate and does not cause additional expenses to be incurred by the individual’s heirs in liquidating the asset. Nor will the value of the home cause their taxable estate to increase on their deaths, which might be important if we go back to a $3.5 million dollar exemption as candidate Biden proposes. In short, this  estate planning step is simple, easy to understand, and cheap (the cost of an appraisal and deed preparation) and may help to avoid federal estate taxes.

There is also more flexibility with the gift of a remainder interest when compared to a charitable remainder trust or a charitable gift annuity. The minimum 10% value gifted to the charity required with a charitable remainder trust does not apply to the gift of a remainder interest in a home or farm. A fractional interest, like a tenant in common interest in the real estate, can also be the subject of the gift of a remainder interest to a charity.  A term of years can be used instead of a retained life estate by the donor. Conceivably more than two life estates could be retained in the deed,  e.g. parents and a disabled child who lives with them, unlike most charitable remainder trusts. The charitable gift can be made even if the home, cottage, or farm is encumbered by a mortgage.

AFR Interest Rate: The value of the remainder interest in the home, cottage, or farm that is given to the charity is calculated using the IRC 7520 rate of interest for the month of the gift. As was previously reported, the interest rates used to value remainder interests for June, 2020, are the lowest in history. The lower the interest rate used, the larger the value assigned to the gifted remainder interest to the charity.

Example: Husband and wife own a cottage valued at $400,000. Their children live far away, and it is highly likely that upon the couples’ deaths, their children will sell the cottage to which they have little emotional attachment. Husband and wife are each age 75. The IRC interest rate for June, 2020 is 0.060%. A deed to the cottage is given to the couple’s favorite charity, in which husband and wife retain joint life estates. The value of the remainder interest given to the charity is 76% of the cottage’s fair market value, or $304,000. For comparison purposes, when the published IRS  IRC 7520 rate of interest was 2%, the value of the gifted remainder interest would have been 56% of the cottage’s fair market value, or a $224,000 income tax deduction. Thus, the cottage owners will have a $304,000 charitable income tax deduction to use. With such a large income tax deduction, the couple will use some of the income tax deduction this year to shelter their taxable income, and they will probably carry-forward the unused portion of the charitable income tax deduction for the following 5 tax years.

Roth Conversion Planning?: The couple might consider using the large charitable income tax deduction generated by the gift of the remainder interest in their cottage to their favorite charity to off-set the additional taxable income that they will report if they decide to convert a portion of their traditional IRAs to a Roth IRAs. They could use the carry-forward charitable tax deductions of off-set future Roth conversions over the following 5 years. Their children might enjoy inheriting a Roth IRA (tax-free income for 10 years) more than a cottage that they will have to sell when their parents die.

Conclusion: This is just one of the many estate planning opportunities that can be used when the current  interest rates are so low and we start to think about what the federal estate tax exemption might fall to in the next couple of years.