Jan. 31, 1996, was a bitingly cold Wednesday as my wife and I awoke to 20 below with high winds. Lying in bed bemoaning another brutal winter day, we vowed to never spend the entire month of January in Green Bay, Wis., again. We fulfilled that promise to ourselves by moving some of our “chips” to Florida as an essential part of the plan.
Coincidentally, by the end of ’96, I received my CCIM pin, my beloved Packers were winning their way to a Super Bowl XXXI, and an article appeared in the December issue of Commercial Investment Real Estate written by Michael McCready, John Cole, and Michael Gorak on private annuity trusts (PATs). That article opened with, “Capital gains taxes are an issue that all investors face. Upon the sale of highly appreciated commercial real estate assets, investors must decide whether to pay the capital gains taxes that are due or use one of the various available methods to defer the taxes.” The balance of the article spoke to estate planning and tax deferral. In addition to PATs, the authors also discussed the benefits of a charitable remainder trust. Little did I know then how this would come into play 25 years later. I’m not sure what prompted me to clip that article from the magazine, but I did — and still have it in my estate-planning folder today.
In our search to escape the Midwest in January, southwest Florida hit our radar screen, and the process began. Being clueless as to where in this area we should make a new investment, we received great guidance from Mardi O’Brien Parker, CCIM, a friend from Madison, Wis., who had started her asset relocation process to the Ft. Myers, Fla., area a few years earlier. Florida is loaded with barrier islands, and Mardi pointed us toward Sanibel Island to start the search.
The Sanibel Island market was reasonably robust at the time, and values were on the rise. We eventually managed to contract on a two-bedroom, two-bath condominium on the beach at the Loggerhead Cay condominium complex.
To fund this purchase, we exercised a 1031 like-kind exchange with a couple of duplex units we had owned in Green Bay for five years. I had a buyer in my pocket for the units, and that gain was deferred into the new condo. We were also deferring the gains from two previous exchanges dating back to 1976. Carrying those adjusted bases forward 20 years left us with a diminished basis in our new investment — but we had our winter retreat.
Of course, investment property is just that, so we aggressively rented our unit as frequently as possible, only visiting when vacant from time to time. Twenty-five years is a long time to own a property like this, and after enduring two major hurricanes and two remodeling jobs, we tired of its upkeep. Expenses kept increasing to a point where our cash flow had diminished to $10,000 annually.
Selling the asset outright with its basis at a minimum would result in a large capital gain and a six-figure tax bill. I had never paid on a capital gain on real estate and wasn’t going to start now. We explored more deeply the nuances of a charitable remainder trust (CRT) as an alternative.
The CRT code of the IRS has been in place since 1969, with section 664 providing for this split-interest trust to benefit both qualified charities and the donor. Our Loggerhead Cay condo was a textbook candidate for the charitable remainder trust because it was highly appreciated, highly depreciated, and underperformed as an investment asset. After 25 years, the mortgage had been fully amortized, so the property was free and clear. Any remaining debt may have been subject to forgiveness and thus taxable. (Consult your attorney for specifics about your situation.)
Our condo was a textbook candidate for the charitable remainder trust because it was highly appreciated, highly depreciated, and underperformed as an investment asset.
I was fortunate to make the acquaintance of Lowell Shoenfeld, a Florida board-certified will and estate attorney who specializes in such deferral products. Lowell guided us through the process and created the charitable remainder trust for my family.
In our personal trust, we had provisions for charitable donations at the time of our deaths to the usual beneficiaries — the Scouts, our church, our alma maters, etc. Those collective donation amounts totaled approximately $350,000. Lowell rewrote our personal trust and moved those beneficiaries into the newly formed charitable remainder trust. Lowell also connected us with the South Florida Foundation, now known as the Collaboratory, a two-building, 24,000-sf center in Fort Myers providing collaborative office space for nonprofits and a technology hub that will be available to both residents and businesses.
For the CRT to provide annual distributions, it must be liquid. The trust had to be funded by the sale of the asset. The proceeds of the sale were approximately $700,000 and deposited with the Collaboratory, with approximately half the balance of the trust coming to our benefit over a 20-year period. Using my trusty HP 10BII calculator, I calculated the annual payout to us from the trust that would amortize its balance over the 20-year trust period to approximate the $350,000 distribution. The payments to our family diminish over that period, but still outperform the asset that was liquidated to accomplish our goals.
The liquidated funds are in complete control of the Collaboratory and invested under its guidelines. Reports, tax filings, distributions, and K-1s are its obligation. A lengthy look back of its fund’s performance indicated an average annual return of approximately 8 percent. With our family receiving 10.75 percent of the declining balance annually for the next 20 years as set forth in the CRT documents, our initial annual distribution is in excess of $70,000. This amount that is subject to taxation, though distributions from the trust are taxed favorably and average below ordinary income tax rates. Interest and dividends earned from the investment vehicle are taxed ordinarily, but additional funds paid out are taxed at capital gain rates.
For the charitable remainder trust to provide annual distributions, it must be liquid. The trust had to be funded by the sale of the asset.
At Lowell’s suggestion and with the foundation’s reluctance to manage the property, I was named the interim trustee during the sale period. To do so, a separate bank account was created to segregate the rents and expenses of the property from our personal accounts. We proceeded to list the property at $799,900 upon the recommendation of a local island REALTOR®. An agonizing COVID-19-related 22 months later, we accepted an offer that netted us the approximate $700,000.
Upon the effective date of the funding, I assigned my trusteeship to the Collaboratory, thereby ending our Loggerhead Cay chapter. Additionally, the donation qualified for a one-time tax deduction dependent on the estimated residual value of the trust at its termination. Because the property was donated to the trust a year prior and before its sale and liquation, we were able to deduct approximately $85,000 that tax year. The process required a certified appraisal to determine value at the time the property was placed into the CRT, with an independent appraisal indicating a value of $775,000. The deduction is determined by the estimated residual (remainder) value of the trust (the donation) and the IRS “hurdle rate,” which is determined monthly in accordance with section 7520 of their code. (I highly suggest your legal team make this determination.)
In the end, we rid ourselves from the management of our condominium, received an immediate income tax deduction, and established a significant cash flow from the property in the form of an annuity for the next 20 years that comes to us while also solidifying our intent to our beneficiaries.
While snow and cold were the motivating factors back in 1996, we no longer have to endure winter’s wrath as we split time between Fort Myers and Green Bay — only enjoying winter’s elements when we are north for the holidays.
