Did you know that there's a way to sidestep a substantial capital gains tax burden by donating your appreciated property to charity? Did you know that you can continue receiving the stream of income that your donated property gives off?
The super wealthy have long known that making money and helping others aren’t incompatible endeavors. The good news is that you don't have to be Warren Buffett to use some of the most powerful tools in estate planning.
While most think of charitable gifts made in cash, don't ignore the important tax advantages of donating non-cash property that has appreciated. Case in point: charitable giving plans, which allow individuals to pass appreciated assets along to charitable institutions.
Charitable giving plans allow you to direct funds to your favorite charity, while simultaneously reducing the cost and tax burden normally involved in gifting property. It’s an investment hat trick: reduce or eliminate capital gains taxes, receive an income tax deduction, and increase your regular or retirement income.
One of the most powerful elements of donating property under a charitable giving plan is that when you make your donation, your deduction is based on the full fair market value of the property, rather than just its cost. So if you're donating property that has appreciated greatly over the years, your tax savings could be impressive. Instead of paying taxes to the government, you can invest those tax savings in any number of income-generating ventures.
And donating via charitable giving plans is a great way to give something back to society. As Winston Churchill once said: “We make a living by what we get, but we make a life by what we give.”
Below are thumbnail sketches of the most popular charitable giving plans. For more information on how to create and operate one, consult an experienced estate lawyer.
Charitable remainder annuity trusts are 'irrevocable' trusts. An irrevocable trust is a permanent gift; you can’t change your mind.
With an annuity trust, the charity invests and manages the donated money or property and pays the donor the income. The income stream is based on a prescribed percentage of the property’s fair market value on the date it's donated.
When the annuity trust is created, you receive a tax deduction for the property gifted. Upon your death, the property in the trust goes to the designated charity.
The advantages to the donor: initial income tax deduction, avoidance of capital gains tax at the time the trust is created, and possible federal estate tax savings. For these reasons, chartable remainder annuity trusts are among the most prevalent charitable giving plans.
Under a revocable charitable trust, you can gift real estate, cash, or other property, knowing that part or all of it can be returned during your lifetime. A revocable trust remains under your control. You can change the terms, the beneficiary, or cancel it altogether.
This type of trust is a great option for people who are reluctant to give to a charity because they may need the money later.
Trust income that accumulates during your lifetime can be paid to you, another person, or a charitable organization, whichever you specify. But because you can request the property back at a later date, the trust confers no income tax advantages. Since, as the trustee, you still have control, you must report the generated income on your tax return.
Though you don't receive the income tax benefits, your estate will receive estate tax benefits. Since title to the property is transferred under the terms of the trust agreement, it doesn’t pass through your will and probate and thereby avoids taxation as part of the estate.
Pooled Income Fund
Pooled income funds operate like mutual funds. In return for contributions to the fund, you receive an income stream for life and an immediate tax deduction.
A trustee invests the entire fund and contributors receive a pro rata share of the earnings each year. Your income may vary from year to year, as the fund’s size fluctuates. When a donor dies, his or her shares are transferred from the fund to the charitable institution.
With a gift annuity, you make a gift to a charity and receive annual payments for life.
The size of the payments depends on how old you are when you make the gift; the older you are, the larger the payments. The formula is partially based on complex mortality tables issue by the federal government. You’re allowed a tax deduction on a portion of the gift, again depending on your age.
Life Estate Agreement
This type of plan allows you to transfer title of your home to a charitable cause but retain the right to live there for the rest of your life. You’re still responsible for upkeep, but you can claim a tax deduction in the year that you made the gift. After you die, the charity receives the property to use as you directed.
The Investing Answer: Regardless of which option you choose, you’ll find charitable giving plans to be an enlightened form of financial self-interest. If you would like to learn more about donating to your favorite charity, including how to avoid con artists posing as altruists, see our educational article, Shrewd Philanthropy: How to Give Without Getting Taken.