Real Estate Operations

Exit Strategy

IS THE TIME COMING TO GET OUT?
by Rex H. Levi - Real Estate Manager - Pepperdine University

As a real estate owner, have you given thought to what will become of your holdings in the future? Or, are you a real estate professional with clients who are unsure of their real estate exit strategy?

Planning ahead is one of the most difficult challenges of real estate ownership. Not only is it hard to estimate your circumstances in your "mature" years; but who knows what the market conditions will be when it is time to get out? Planning now for unknown market conditions in the future is a daunting thought, and many will put off the forethought needed to come to their desired result, or worse yet, just ignore the task altogether. Perhaps the time to get out of real estate is now approaching. Test yourself by asking these questions:

Would you like to divest some or all of your real estate portfolio but HATE the idea of paying Uncle Sam significant capital gain taxes?

Are you tired of managing and trading into other property has absolutely no allure to you?

Are you concerned about how your real estate will be handled if you don’t make arrangements prior to death?

Have you avoided spending an arm and a leg on legal advise to determine disposition options for either now or in the future?

If you answered YES to any of these questions what follows will be of interest to you. Thanks to IRS tax rulings, there are plans and techniques that are specifically beneficial as real estate exit vehicles. These plans: 1) incorporate charitable giving; 2) provide maximum income while alive; 3) avoid capital gain taxes on the sale of appreciated assets; and, 4) shrink estate size down to reduce or completely eliminate the applicable "death" transfer tax occurring on estates in excess of the current exemptions. Welcome to the world of CHARITABLE REMAINDER TRUSTS and CHARITABLE GIFT ANNUITIES.

For years the U.S. Government has offered incentives to taxpayers interested in liquidating assets in support of worthy non-profit causes. These assets can include stocks, art and most importantly, real estate. What is surprising is that these plans often provide significantly more income and benefit than actual ownership of the property asset, or selling the asset on the open market!

By utilizing programs such as the Charitable Remainder Trust, you effectively pull your assets out of your estate alleviating estate taxes upon death. Additionally you gain a tax deduction from the IRS, upfront, based on the value of the asset charity will receive. This number is calculated using life expectancy tables. In other words, the IRS allows the donor to take a write off now for an asset that doesn’t turn into a gift until death. What a great concept…you commit to charity today, you don’t pay any capital gain taxes, you get significant tax credits up front, you utilize the entire principle of the real estate asset to generate a permanent income flow in the form of monthly or quarterly payments. Additionally, the principal is safe from legal actions of creditors, plus the risk of losing cash flow due to self-inflicted bad investments is removed.

This all happens by either placing your asset in a trust (charitable remainder trust) or by transferring the asset to a charity in exchange for a binding contract guaranteeing income for life or longer (charitable gift annuity). The objective is to give you more while you are alive and more to your heirs and loved ones when you are gone! Choosing one of the handful of charities that offer these programs is an important decision. It takes forethought, planning, and management expertise on the part of the charity to best manage the growth of your asset whether it be held or sold off. When looking at these programs, it is important to work with organizations whose objective is not only to raise funds, but, to maximize an estate AND to take an interest in the what is best for the real estate owner.

Many do not realize that non-profits do not treat and handle these plans in the same way. Often people think "fire sale" when charitable organizations dispose of real estate. Sadly, this happens with many charities that lack the savvy and sophistication to deal with real estate, or they just do not have the resources to handle real estate gifts with the finesse and attention that such transactions require.

Fortunately, some charities are proficient in creating win-win scenarios using these programs. Some even go further by offering in-house estate planning, CPA consultation, and full service real estate property management. When seeking a charity to partner with, differentiate between those that place the gift as the first priority as opposed to those that take the interests of the donor, the donor’s estate and the donor’s heirs as a priority. Ask about their track record and the terms of some of their recent deals. How successful has their investment strategy been? And, if the transaction is sizable, are they willing (and happy) to include one or more of your favorite, smaller charities as an additional gift beneficiary in the plan?

Lastly, these programs can eliminate the "death tax!" President Bush has advocated the repeal of the estate tax (a.k.a the death tax), but with the aftermath costs attributed to the 9/11 terrorist war and Congress’s shift to a deficit spending budget, I believe this aggressive tax ranging from 41-50% will be sticking around. This year these taxes are making a killing on estates valued in excess of $1,000,000 for an individual ($2,000,000 for couples) that have not planned effectively. However when used right, the charitable plans I’m suggesting can provide:

Significant more wealth for your dependents and loved ones;

Preventing the government from taking a large portion of your estate (sometimes requiring the sale of assets just to pay the taxes); and

Help to your chosen causes and the recognition and satisfaction for those contributions while providing a personal legacy.

It’s great to give to something worthwhile and it’s that much sweeter when it’s money that would have gone to Uncle Sam. These plans offer some of the few available tax strategies left to ordinary taxpayers and come in an array of options depending on the needs of the real estate owner and his/her estate.

Here is a chart of one example of the many different types of programs that can be structured:

Comparison of Outright Sale vs. Charitable Remainder Trust:
2 Lives, Age 75, with a Federal Rate of 5.4%

INCOME		OUTRIGHT SALE	CHARITABLE REMAINDER TRUST
1.	Net Sales Proceeds	$1,000,000	$1,000,000
2.	Less: Tax Basis	$100,000	n/a
3.	Net Long-Term Capital Gain	$900,000	None
4.	Blended State/Federal LTCG Rate	27.44%	n/a
5.	State/Federal Taxes	$246,960	n/a
6.	Net After-Tax Proceeds	$753,040	$1,000,000
7.	Pre-tax Earnings/Annuity Rate	7%	7%
8.	Pre-Tax Return	$52,713	$70,000
9.	Federal/State Income Taxes @ 44.31%	$23,357	$31,017
10.	After Tax Earnings (yearly)	$29,356	$38,983
Income Tax Deduction
11.	Income Tax Contribution Deduction	None	$386,180
12.	Total Cash Savings from Deduction	None	$171,116
13.	Annual Cash Savings for 6 years	None	$28,519
Total Benefits
14.	Yearly After Tax Income
	Years 1-6	$29,356	$67,502
	Years 7+	$29,356	$38,983

Assumptions: Market value of $1 million; 44.31% combined federal/state tax rate; annual earnings of 7%; a tax basis of $100 thousand; a couple aged 75; Applicable Federal Rate of 5.4%.

Note: The cost of full-value replacement survivorship life insurance, if desired, is estimated at $18 – 26 thousand per year up to 100 years of age- after that (God willing?), no premium.

An insurance policy option should also be looked at for wealth replacement opportunities. Set up correctly, this option leaves tax-free money to those you want to take care of via your estate when you are gone. This example uses roughly half the cash flow to provide one million dollars tax free to loved ones.

Will charitable gift plans make sense for everyone in all situations? Of course not. But as a rule of thumb, the older you are, the greater the value of your capital appreciation, and the greater your need for a tax deduction, the better your numbers will look. So, the next time you (or someone you know) are looking for the "Exit" sign, don’t overlook going to your favorite charities for some ideas.

Rex H. Levi is the Real Estate Manager at Pepperdine University, an industry leader in the use of charitable life income plans. Currently, he oversees a portfolio with a cost basis of over $70,000,0000 and has over $25,000,000 in pending escrows. Year 2001, he and his staff sold over $9,000,000 and year 2000 over $20,000,000.