Home Sweet: Income Producer?

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In this era of declining returns on investments, the most valuable asset in many of my clients' portfolios is the family residence. Unfortunately, unless you are willing to bake scones for the bed and breakfast crowd every weekend, or convert the kid's room to a rental, the family residence is usually not income producing. One option is to pull equity out of the home and reinvest in the stock market or certificates of deposit. Of course, that takes us right back to the original problem of dismal declining returns on investments.

Another option is to pull the equity out and invest in rental property. The problem with that is rents, at least in Southern California, have remained rather stagnant. Additionally, you either have to be very handy about minor repairs and very adept at screening renters and collecting rents, or you need to hire a property manager, at an average fee of 10%.

Another option some people are discussing now is essentially a charitable reverse mortgage. More and more qualified charities will work with you on this. It works like this: The homeowner donates a personal residence, which may be the primary residence, vacation home, second home, or farm, to charity. If a farm, the homeowner need not reside on the property. The homeowner retains a life estate in the residence. After deeding the home to charity, the donor continues to retain the full use, possession and enjoyment of the residence or farm. The donor continues to maintain and insure the home and pay the real property taxes. So far, pretty standard stuff. But, wait, there's more.

In addition to the use of the residence, the charity pays an annuity to the donor, for life. The annuity amount is based on the value of the remainder interest of the residence donated to the charity. In order to determine the correct amount of the annuity, a certified appraisal of the residence is obtained. The appraised value is then divided using Internal Revenue Service life expectancy tables and the Applicable Federal Rate. The first part represents the donor's right to remain in the residence for life. The second part (the "remainder interest") represents the charity's interest in the residence once the donor has passed away. The amount of the annuity which can be paid to the donor is calculated by multiplying the remainder interest by the appropriate annuity rate. The appropriate annuity rate is based on the age of the donor when the gift is made.

Of course, there is some income tax payable on the annuity payments received by the donor. However, a portion of that is even tax-free as a return of principal.

If, as is most likely, the residence has appreciated, a pro rata portion of the annuity is subject to capital gains tax but even that may be treated as tax-free, depending on the circumstances because the capital gains tax exclusion of $250,000 for an individual or $500,000 for a married couple is still available.

At your death, the residence passes to the charity. If you have beneficiaries who would feel slighted by this arrangement, life insurance can often be purchased to supplement the lost inheritance.

Finally, it is famous last words to say this is the perfect plan for you because you "will never leave this house." Things change. I can't tell you how many people have told me that and then their circumstances or their preferences changed and they did indeed leave the house they said they'd never leave. That's okay. Even though the arrangement is "irrevocable," you will still have some flexibility. If you need or want to leave your home because you want to move closer to other family members, or you want to move into a residential facility where you will receive more personal care, or for any other reason you need or want to move, you may lease your home to a third party or your lifetime interest may be sold or donated. This strategy is not for everyone, but for lots of people, it is worth considering.

The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.

Copyright 2011 © by Jacqueline M. Skay. All rights reserved. You may reproduce materials available at this site for your own personal use and for non-commercial distribution. All copies must include this copyright statement.

Estate and Trust Law
A Professional Law Corporation

Jacqueline Skay - Attorney at Law

760.745.7576
jskay@estateandtrustlaw.com

Home Sweet: Income Producer?

Click here to return to Our Newletter.

In this era of declining returns on investments, the most valuable asset in many of my clients' portfolios is the family residence. Unfortunately, unless you are willing to bake scones for the bed and breakfast crowd every weekend, or convert the kid's room to a rental, the family residence is usually not income producing. One option is to pull equity out of the home and reinvest in the stock market or certificates of deposit. Of course, that takes us right back to the original problem of dismal declining returns on investments.

Another option is to pull the equity out and invest in rental property. The problem with that is rents, at least in Southern California, have remained rather stagnant. Additionally, you either have to be very handy about minor repairs and very adept at screening renters and collecting rents, or you need to hire a property manager, at an average fee of 10%.

Another option some people are discussing now is essentially a charitable reverse mortgage. More and more qualified charities will work with you on this. It works like this: The homeowner donates a personal residence, which may be the primary residence, vacation home, second home, or farm, to charity. If a farm, the homeowner need not reside on the property. The homeowner retains a life estate in the residence. After deeding the home to charity, the donor continues to retain the full use, possession and enjoyment of the residence or farm. The donor continues to maintain and insure the home and pay the real property taxes. So far, pretty standard stuff. But, wait, there's more.

In addition to the use of the residence, the charity pays an annuity to the donor, for life. The annuity amount is based on the value of the remainder interest of the residence donated to the charity. In order to determine the correct amount of the annuity, a certified appraisal of the residence is obtained. The appraised value is then divided using Internal Revenue Service life expectancy tables and the Applicable Federal Rate. The first part represents the donor's right to remain in the residence for life. The second part (the "remainder interest") represents the charity's interest in the residence once the donor has passed away. The amount of the annuity which can be paid to the donor is calculated by multiplying the remainder interest by the appropriate annuity rate. The appropriate annuity rate is based on the age of the donor when the gift is made.

Of course, there is some income tax payable on the annuity payments received by the donor. However, a portion of that is even tax-free as a return of principal.

If, as is most likely, the residence has appreciated, a pro rata portion of the annuity is subject to capital gains tax but even that may be treated as tax-free, depending on the circumstances because the capital gains tax exclusion of $250,000 for an individual or $500,000 for a married couple is still available.

At your death, the residence passes to the charity. If you have beneficiaries who would feel slighted by this arrangement, life insurance can often be purchased to supplement the lost inheritance.

Finally, it is famous last words to say this is the perfect plan for you because you "will never leave this house." Things change. I can't tell you how many people have told me that and then their circumstances or their preferences changed and they did indeed leave the house they said they'd never leave. That's okay. Even though the arrangement is "irrevocable," you will still have some flexibility. If you need or want to leave your home because you want to move closer to other family members, or you want to move into a residential facility where you will receive more personal care, or for any other reason you need or want to move, you may lease your home to a third party or your lifetime interest may be sold or donated. This strategy is not for everyone, but for lots of people, it is worth considering.