Retained Life Estate: Open the Door to Tax Charitable Deductions

Lisa Knott |

A home is a place to rest your head, to create memories, and to cook dinner. It’s where your pets are—your family. What people most often forget about their home is that it’s also your most valuable financial asset. And, if one of your financial goals includes a testamentary gift to charity, while also receiving substantive income tax deductions, this asset is important.  

What’s unique about your home as an asset is you can use it as not only a place to live, but also to make a difference in the world of a charity and on your tax returns. Seriously. Under the terms of a retained life estate you can bequeath your house to your favorite nonprofit organization and in turn get favorable tax breaks. But, don’t worry, you don’t have to pack up the moving truck following such a good deed. The key to you, as the donor, keeping the keys to the front door is the term “retained.”

Even though a donor definitively donates a personal residence to a nonprofit organization they retain the right to live in the house in it for a term such as the rest of the life of the donor (and others, such as a spouse). Then, after the death of the donor(s) or following some other predefined number of years defined in the life estate, the real estate rights are transferred completely to the charity.

This financial asset is a win-win for both parties. The charity has valuable real estate to either sell and use the income as the donor wished, or keep and use the property. And, the donor gets a healthy federal income tax charitable deduction.

What does a Residence mean, exactly?

It’s important to remember that a personal residence doesn’t have to be a primary house one lives in. It could be a lake house or city apartment. A farm—raw or with buildings—can also be donated.

While it may seem easier to simply “donate” all the furniture and impressionist paintings along with the residence, as far as the IRS is concerned your stuff doesn’t count as a part of the estate tax charitable deduction. If you do want to donate your heirlooms to a charitable cause, you’ll need to separately bequeath them.

Taking Care of Taxes

No deductions are allowed for contributions of partial interest in property on federal income taxes unless (a big unless), the contribution is in the form of a charitable remainder unitrust, pooled income fund, or qualified charitable remainder annuity trust. On top of that, there are some qualifying exceptions to the partial interest in property such as: a donation of a remainder interest in a personal residence; qualified conservation contribution; and a contribution of an undivided portion of the taxpayer’s entire interest in property. So, basically, you’re going to enjoy healthy income tax deduction

Like all charitable financial donations, gifts that involve appreciated property, such as the real estate, have a tax deduction limitation of up to 30 percent the donor’s adjusted gross income. Plus, any leftover portion of the remainder interest value can be carried over on taxes for up to the five following years.

Donors can receive a charitable deduction on federal taxes in an equal amount to the net present value of charitable remainder interest. This value involves a number of factors in a somewhat complicated equation including: fair market values of the property and depreciable improvements/depleted resources, salvage value of depreciable improvements at the end of their use, and the Applicable Federal Midterm Rate.

Another tax benefit is that the real estate is transferred away from your taxable estate upon death. So, your family and will trustees don’t have to deal with the complications of selling the property.

Terms Time

Donors have a choice of forming the retained life estate so that it’s measured by a lifetime (how long the donor will live and the real estate would pass full to the charity upon the donor’s passing) or by a term of years (or a combination of the two). If a term of years is decided upon it’s important to know there are no maximums or minimums required by the IRS for federal tax purposes. So, this term could be one year or 30.   

Applicable Federal Midterm Rate

The Applicable Federal Mid-term Rate (AFR) is a part of the equation when the interest of the present value of the property is calculated. For a better deduction it’s advantageous to have a lower AFR. So, it’s helpful that the donor can choose to sub the AFR from either of the two months before the month in which the gift is being made in lieu of the present month.

Write Up an Agreement

When a donor is living on a property donated to an organization (or even if that land is farmland) it’s better to establish the rules of engagement up front. It’s wise for the legal protection of both parties to craft a gift agreement that covers details on responsibilities like remodeling and major repairs that may arise, who pays for utilities, and answers questions like: what about liability insurance? What’s the procedure for removal of personal property following the end of the donor’s tenancy? And, since the donor retains “beneficial lifetime rights” of the property it means they can also lease or rent the property out. Since the nonprofit is the owner of the remainder interest they have a big stake in the property and often have a final say over any rental agreements. Again, this has to be decided. It’s also smart to establish a clear dispute resolution process in case issues arise that cannot be easily taken care of between the donor and charity.

Seek Out Expert Advice

Every situation is unique when it comes to the interplay between a donated personal residence and tax situation. Your financial advisor is a good place to start with understanding the full picture and all the options surrounding a retained life estate for your financial situation. In addition to a great financial advisor, it’s also important to have a trusted lawyer to help guide you through any legal snares.



*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.