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Monday June 27, 2022

Case of the Week

The Gift of Philanthropy to Two Sons


Lorraine Moore, a widow age 75, has an estate valued at $1 million. Her estate consists of her home valued at $100,000, liquid investments of $400,000 (primarily bonds and stock) and an apartment building valued at $500,000. As a former high school history teacher, she lives comfortably with her pension and the income from her investments. The apartment building generates an income stream of about $20,000 per year after expenses.

However, the apartment property is continuing to age and, because of recurring repairs, she is growing tired of dealing with the responsibilities of the day-to-day management. Her husband passed away five years ago and he enjoyed taking care of the property during his retirement. He knew many of the tenants personally and, in many cases, was the handyman handling most of the repairs.

Lorraine has lived in Fargo, North Dakota most of her life, but would like to purchase a winter home in Arizona to enjoy the winter sunshine. However, the management of the apartment building has kept her tied closely to the property. She has fully depreciated the building and her adjusted basis in the property is only $25,000. She thought about selling the apartments a number of times, but was always discouraged by her CPA due to the capital gains tax problems. Lorraine never could justify paying over $100,000 in tax to sell the property. Apart from the tax bite, she would love to unload the property and be free from its burdensome responsibilities. In fact, she recently received a tentative offer of $500,000 on the apartments. Even though she has not formally accepted the offer, she is seriously considering selling.

During retirement, Lorraine has continued to be active in tutoring high school students at the private high school where she taught many years ago. She has made charitable contributions to the school and to other community related organizations. She would like to see some of her capital preserved for these types of organizations when she is gone. Lorraine's two sons, who both teach at the private school in Fargo, have many similar ambitions and charitable interests. She would like to see them have control of some of the capital of her estate for charitable purposes after she passes away.


Lorraine's desire is to sell the apartment building, but she would like to avoid the capital gains tax. Because she is receiving income from the property, she would like to continue to receive income from the sales proceeds. Finally, she would like to see her sons retain some control over the proceeds of the sale when she is gone. In other words, Lorraine would like to see the family administer the estate's "social capital."


She posed these questions to Tim, who is Director of Major Gifts at Favorite Charity. Tim stated that these concerns could all be addressed by using a charitable remainder trust. The charitable trust would be funded by the apartment building and then would be sold within the trust, thereby bypassing the onerous capital gains taxes. Tim stated that she would have the option to choose the distribution percentage on the trust. After discussing these options, Lorraine chose a payout percentage of 5%. She will receive a charitable income tax deduction of over $299,000. With her 26.9% federal and state combined income tax bracket, this will produce income tax savings in excess of $80,000. Because she chose a payout rate of 5%, she can expect to receive an annual distribution of $25,000 per year, which may increase in future years.

Lorraine was very impressed with these benefits -- great lifetime income, a tax deduction and bypass of capital gains taxes. But how would the trust preserve the family's social capital? Tim replied that the trust must have a charitable remainder interest. In other words, when she passes away, the trust assets must then be transferred to a qualified charity. He suggested that the trust could eventually be distributed to Favorite Charity to establish a donor advised fund (DAF) under her family's name. Since her sons have the same charitable interests as Lorraine, they would be given the right to direct those assets held by the DAF to various charities for a specified period of time, such as for twenty years after Lorraine passes away. In this way, they would control the family's social capital for a number of years after Lorraine's passing.

Lorraine was delighted with the charitable remainder trust concept. She is able to fulfill not only her financial and tax-related goals, but is able to preserve her family's social capital as well.

Published July 9, 2021
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