Gift of a Remainder Interest in a Personal Residence or Farm to Charity – Why Now?

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Overview


The Gift of a Remainder Interest in a Personal Residence Or Farm to Charity is a special technique that fits a small set of charitable donors. For those to whom it does apply, historically low interest rates make now the time to implement.

In Depth


A Gift of a Remainder Interest in a Personal Residence or Farm (GRIPROF) to Charity is a statutorily sanctioned transaction that produces a current income tax charitable deduction for the donor with no current out-of-pocket cost. The GRIPROF to Charity has been on the books for a very long time, but now may be a particularly good time for this transaction because interest rates are so low.

The Internal Revenue Service (IRS) 7520 rate (the monthly rate declared by the IRS for calculating various partial interests in property) has fallen to 0.8% as of May 2020. In May 2019, the 7520 rate was 2.8%. We explain below why that big drop is so significant for a GRIPROF. But first, what exactly is a GRIPROF, and which donors are candidates for its use?

How Does a GRIPROF Work?

As the name suggests, the donor in a GRIPROF transaction transfers her residence to charity, retaining the right to live in the residence for the rest of her life. After the transfer, the donor continues to pay all the expenses that she previously paid, just as if the transfer had never taken place. At the donor’s death, the charity will own the residence free and clear.

Under tax law, the donor is allowed a federal income tax charitable deduction equal to the actuarial value of the charity’s interest in the property. The size of that income tax deduction depends on a number of variables:

  • Value of the land on which the residence sits
  • Value of the residence
  • Useful life of the residence in years
  • Salvage value of the residence at the end of its useful life
  • Donor’s age at the time of the gift
  • IRS 7520 rate at the time of the gift.

The prime candidate for a GRIPROF to Charity is a donor who is committed to leaving a large portion of her estate to charity. For that donor, the GRIPROF is a “prepayment” on that commitment, but a prepayment that requires no immediate or future outlay of cash or securities. While the cost to the donor of maintaining the residence remains the same, the transaction produces an immediate charitable income tax deduction that provides a cash benefit to the donor. Below are two examples:

Example 1: Tom and Brenda are both 70 years old. Their home was appraised recently at $10 million. Half the value is in the land, and half is in the residence. The appraiser opined that the useful life of the residence is 35 years, and at the end of that time the residence will have a salvage value of 20%, or $1 million. Tom and Brenda transfer their residence to their alma mater, retaining the right to live in the residence until the second of them dies. Based on these assumptions and a 0.8% 7520 rate, the charitable income deduction is $6.82 million. If Tom and Brenda’s effective federal income tax rate is, for example, 28%, and they can deduct all of that amount on their current tax year return (and if they cannot, the unused deduction can be carried over for up to five years), then their 2020 income tax savings is $1.9 million.

If instead of age 70 Tom and Brenda were both 80, then the income tax deduction jumps to $7.95 million and the corresponding 2020 income tax savings to $2.2 million.

Example 2: Violet, age 70, owns a cattle ranch worth $10 million (exclusive of the minimal improvements and the cattle). Violet transfers the ranch to her alma mater, retaining the right to possession of the ranch during her lifetime. Based on these assumptions and a 0.8% 7520 rate, the charitable income deduction is $8.94 million. If Violet’s effective federal income tax rate is, for example, 28%, and she can deduct all of that amount on her current tax year return (and if she cannot, the unused deduction can be carried over for up to five years), then her 2020 income tax savings is $2.5 million.

If instead of age 70 Violet was 80, then the income tax deduction jumps to $9.36 million and the corresponding 2020 income tax savings to $2.6 million.

If, instead of engaging in the GRIPROF to charity, the donor retains the entire property, leaving it to charity at death, there is no charitable income tax deduction or savings.

Why Consider a GRIPROF Now?

The lower the applicable interest rate, the lower the value of the donor’s retained life interest and the higher the value of the charity’s remainder. It’s no surprise then that today’s 7520 rate of 0.8% when compared to the 2.8% rate from a year ago produces markedly better results, as the table below illustrates. Today’s results are more than 40% better for the joint life example and almost 30% better for the single life example.

Donor Age Deduction at current AFR – 0.8% Deduction at AFR of one year ago – 2.8% Percentage benefit at 0.8%
Tom & Brenda 70 68.19% 48.55% 40.45%
Violet 70 89.42% 68.96% 29.67%

The GRIPROF to Charity is a special technique that fits a small set of charitable donors. But for those to whom it does apply, the historic dip in interest rates makes now the time to implement.