Case: Rhea Jones, 75, lives in a beautiful coastal town in northern California.
Rhea's home occupies three magnificent acres of bluff property that
overlooks the crashing waves of the Pacific. Since her home sits just
steps away from the dramatic cliffs, Rhea frequently jokes to her friends
about her "living on the edge" lifestyle.
John, Rhea's husband of 50 years, built the custom home ten years
ago. It was truly the realization of a lifelong dream of John and Rhea.
Unfortunately, John passed away unexpectedly five years ago. Now, Rhea
lives alone in the large home. Nevertheless, Rhea is looking forward to
spending her remaining days in this lovely home. Not surprisingly, she
frequently plays host to her children, grandchildren and friends.
Rhea is an active philanthropist. In fact, she spends three days a week
volunteering with local charities. While very wealthy and philanthropic,
Rhea makes only modest yearly gifts. However, she intends to make a substantial
bequest upon her death. Specifically, Rhea plans on distributing her entire
estate to her children and grandchildren, except for her cliff-side home.
Rhea's will provides that the home passes to John and Rhea's favorite
charity upon her death. The home is worth $3 million.
However, at a recent estate planning presentation, Rhea discovered the
benefits of a gift of a remainder interest in a personal residence. In
particular, she liked the potential significant tax savings and the home's
avoidance of the probate process. Also, because the gift is irrevocable,
the local charity would recognize and honor Rhea for her generous gift
at the annual fund raising gala. Of course, Rhea would retain the right
to live in her home for the rest of her life, which is an absolute requirement
to any potential gift arrangement.
Question: Rhea is very excited about this gift arrangement, but she has many questions.
Before she commits to the gift plan, she wants to address several issues.
In order to compute the charitable income tax deduction, Rhea is required
to determine the estimated useful life of her home. How does she do this?
Are there some rules regarding this determination? What are the four basic
options to make this determination?
Solution: In determining the value of a gift of a remainder interest in a personal
residence or farm, depreciation must be taken into account if any part
of the contributed property is subject to exhaustion, wear and tear, or
obsolescence. See Sec. 170A-12(b)(1). The tax code requires the straight-line
method of depreciation. In order to compute depreciation, a donor must
determine the estimated useful life and salvage value of the building.
"Estimated useful life" is the estimated period of time that
an individual's property may reasonably be expected to be useful.
In determining this time period, the "expected use" of the property
must be taken into account. See Sec. 170A-12(d). Lastly, the useful life
"clock" starts ticking at the time of a gift and not at the
time the property is built.
Option #1: In an ideal situation, an engineer or other person skilled in estimating
the useful life of similar type property determines the estimated useful
life. In many instances, an engineer will likely determine a very long
useful life. In fact, it is not uncommon for some personal residences
to have a useful life of 50, 60, 70 years or more, which directly translates
into a larger charitable deduction.
Option #2: Alternatively, an individual may request that an appraiser provide information
regarding estimated useful life, since an appraiser is already valuing
the property for income tax valuation purposes. See GiftLaw Pro Chapter
1.5.2 "Form 8283 and Appraiser Qualifications." In the event
the appraiser is competent to provide useful life determinations, this
is an excellent solution. However, many appraisers lack the experience
or knowledge necessary to provide such uniquely detailed information.
In this case, Rhea's appraiser does not feel capable of determining
the estimated useful life of her home. Thus, option #2 is not going to
solve the dilemma. As for option #1, while use of an engineer to determine
useful life is perhaps the most favorable option, this option is costly,
time-consuming and burdensome. As a result, this option is rarely selected,
except perhaps in multi-million dollar situations where the increased
useful life will result in significant five and even six figure tax savings.
Rhea prefers to keep things simple. Accordingly, she is not very excited
about the cost and complexity of option #1. However, she understands an
engineer will likely provide a very beneficial and defensible determination.
Before she makes her final decision, she wants to weigh her other two options.
Editor's Note: There are four primary options for determining estimated useful life.
This case study addresses the first two options. The remaining two options
will appear in Part 5 and 6 of this series. Keep in mind that for gifts
of a remainder interest in land only (i.e., no building), depreciation
will not be taken into account since there is no depreciable component
to the contributed property, as land is not subject to depreciation.
Living on the Edge, Part 3
Living on the Edge, Part 2
Living on the Edge, Part 1
George's "UT to Green Gift Annuity" Conversion