Investing in property may generally offer long-term value at lower risk over time, especially when compared to stocks. Nonetheless, the real estate scene can also be volatile as it is highly dependent on the state of the economy and the housing or property market. As a result, something that previously looked like such a good deal may turn out to be more than you bargained for. Or perhaps you projected a wrong valuation based on a lack of understanding of the property's financials, resulting in substantial losses. An informed and savvy real estate investor will ensure that, from the get-go, clear and well-defined exit plans are in place, such as charitable giving exit strategies like FLIP Charitable Remainder Unitrust (FLIP CRUT). In this post, we'd like to help you dig deeper into what a charitable giving exit strategy is all about, so you can decide if it’s the right exit strategy for you to take.
Why do you need a real estate exit strategy?
A real estate exit strategy is a financial plan that helps protect you from losing money on your real estate deal or enables your removal from it. If it is well-crafted, such a strategy can help you maximize your profits while minimizing risks. Additionally, a robust one can help reduce or even do away with tax ramifications. Examples of real estate exit vehicles include Fix and Flip, where you turn a profit by working on fixer-uppers, or Buy and Hold, where you keep the property to rent it out. While these may help build wealth, a multi-pronged plan that takes your beneficiaries into account may be a more comprehensive approach. A charitable giving exit strategy can be that additional layer of protection to better secure the value of your holdings and also protect your heirs' financial future.
What are the benefits of a charitable giving exit strategy?
Did you know that, although your heirs may not have to settle taxes on money they inherit, they will need to shell out large sums to pay capital gains taxes on other types of endowment, such as securities and real estate? And although the estate pays for that additional substantial levy, inheritance tax, it means that your beneficiaries will be receiving much less after the settlement of all financial obligations attached to the estate. Here is where using a charitable giving exit strategy can be highly beneficial.
Charitable giving is an exit vehicle that effectively helps you hit two birds with one stone. First, it encourages you to support charitable causes or organizations. Second, it provides a financial strategy to help you lawfully enjoy substantial tax benefits as you earn from your holdings. The usual way to establish this is through a charitable trust.
What is a charitable trust?
A charitable trust is an irrevocable trust created to simultaneously benefit the donor, the beneficiaries, and a charitable organization. Setting up such a trust on your real estate means that you, as the benefactor, have decided to sign over or donate it to a philanthropic cause. One way to view it is as a private charitable foundation, which, although not tax-exempt the way public charities are, also awarded significant tax advantages.
What are the principal types of charitable trusts?
Estate planning tools are differentiated according to the initial recipient of the annuity (either the beneficiary or charity) and the type of annuity (either a fixed percentage or fixed amount). An annuity is a fixed payout made to the payee coming from the property's income. Depending on your arrangements, you can also assign yourself as the initial recipient of the payouts while you are still living.
The two main types of charitable trusts are charitable lead trust (CLT) and charitable remainder trust (CRT). In a CLT, you gift your property to an irrevocable trust. Next, you name a charitable beneficiary, which then receives an annuity from the trust's income for a set period. Once the income period ends, the remaining assets are handed over to your non-charitable beneficiaries.
In contrast to a CLT, a CRT allows you or your non-charitable beneficiaries to be the initial recipients of the annuity from the trust. Then, upon your demise, what's left in the trust will be turned over to your charity of choice, who will be the final beneficiary. You may prefer to have a CRT if you or your non-charitable beneficiaries need an income stream. A CRT can further be classified into a charitable remainder annuity trust or CRAT) and charitable remainder unitrust or CRUT.
What's the difference between a CRAT and a CRUT?
Both a CRAT and a CRUT allow your non-charitable beneficiaries to receive a regular payout from their property inheritance for the duration of the trust's term. The income from either a CRAT or a CRUT comes alongside substantial tax benefits given by the government to encourage charitable giving.
The difference between the two lies in how the payout is computed. In a CRAT, the payout is distributed as a fixed amount (based on a fixed percentage of the trust's initial value). On the other hand, in a CRUT, the payout is computed using a fixed rate set at not lower than 5% but not more than 50% of the fair market price of the trust's assets based on their yearly revaluation.
If a fixed amount as your income appeals to you, you may want to go for a CRAT. The downside is that a CRAT does not hedge against inflation, unlike a CRUT, where your property value will be regularly assessed.
What tax benefits can you enjoy from a CRUT?
A CRUT, such as a FLIP Charitable Remainder Unitrust (FLIP CRUT), allows you to save from the time you've set it up by way of an immediate income tax deduction on the present value of your eventual charitable donation. Also, should you decide to sell your property (which you've incorporated into the trust), regardless of how much it has appreciated, you won't have to pay the expensive capital gains tax. Additionally, the proceeds you earn from the sale may once again be reinvested into a diversified portfolio of securities. No matter how much profit you made, a FLIP CRUT payout will only be based on the regular fixed percentage the trust is mandated to distribute. This "flip" or rolling over allows you to keep reinvesting proceeds from the sale of real estate assets in the FLIP CRUT, enabling it to grow more.
The Takeaway
Charitable trusts is one effective way to help protect you from the volatility of market conditions and the risk of unforeseen events. If you are serious about preserving the value of your holdings and ensuring the financial future of your loved ones, do your due diligence and consult your tax and legal advisor today.
