If you’re thinking about selling your home and want to do so in a tax advantaged way, you may be wondering whether it’s better to do so through a Charitable Remainder Trust (CRUT) or to take advantage of the personal exemption — the capital gains deduction that you can take on the sale of your personal residence. Here’s a brief overview of each option to help you make an informed decision.
How do Charitable Remainder Trusts work?
At a basic level, a CRUT is simple: You gift your real estate to the trust, receive an up-front tax deduction worth 10% of the appraised value, and sell when you’re ready. The trust is tax exempt, so it pays (and you pay) no taxes upon sale. You get to reinvest the proceeds and take annual distributions from the trust according to an IRS formula, and when the trust ends, whatever is left goes to the charitable cause of your choice.
How does the real estate personal exemption work?
The personal real estate exemption is a deduction from the capital gains you realize upon sale — $250,000 for single homeowners and $500,000 for married couples. To be eligible for the personal exemption, you must have owned and occupied the home as your primary residence for at least two years out of the five years prior to the sale, and you can’t have used the exemption on another property in the past two years. Of course, if you earn a profit on the sale that exceeds the personal exemption limit, you will owe capital gains taxes on the excess amount.
What are the advantages and disadvantages of selling your property through a Charitable Remainder Trust?
The benefits of using a CRUT to sell your property are threefold: (1) Deduction: You will receive an income tax deduction worth 10% of the value of the assets that are transferred to the trust; (2) Tax smoothing: Because the trust spreads your income distributions out over the length of the trust, you are able to avoid a spike in your income (and the resulting higher tax rate) that would come from a one-time windfall; (3) Tax exemption: When you sell your property, the trust (and you) will avoid up-front capital gains taxes, and you can reinvest all of the proceeds into whatever assets you choose, instead of just the after tax proceeds.
There are also a few tradeoffs, to be sure: (1) The transfer of assets to the trust is irrevocable, which means you cannot change your mind about the arrangement after it has been set up; and (2) there are strict rules about how the trust must be structured and administered, which you can learn more about here.
What are the benefits and requirements of the personal exemption on real estate?
The personal exemption allows you to exempt up to $250,000 of qualifying gains from the sale of your primary residence if you are single, or $500,000 if you are married.
The benefits of the personal exemption come down to convenience: It is a simple process — just a deduction on your tax return, provided that you meet the time and ownership requirements we mentioned earlier — and you’re not restricted in how you can use the proceeds from the sale of your home. You can use the money for personal consumption, investment, or for any other purpose.
If you have a choice between a CRUT and the personal exemption, which is a better fit?
If you use a CRUT, you forfeit the personal exemption. Whether that tradeoff is worth it ultimately comes down to numbers: Will the CRUT save you more over the long run than the $250,000/$500,000 personal exemption? Here is a quick real-world case study comparing these options from a financial perspective.
Our client Austin bought his family’s New York apartment 14 years for $1.3 million, and it’s now worth $7.6 million — that’s a $6.3 million capital gain! Austin’s kids have left home, and he and his wife want to downsize and move to Florida. They plan to sell the home and invest the gains in a diversified portfolio of assets.
- Austin and Jenna are 67 and 64 years old and have kids who are 40 and 38 years old
- They want to maximize the proceeds available to them and their kids over their respective lives
- They expect the stock market to grow 7% annually
Taking no tax breaks. If Austin and Jenna find that they’re ineligible for the personal exemption — say they didn’t live in the house 2 out of the last 5 years — and don’t set up a CRUT, they’d owe about $2.3 million in federal and state taxes (34% of their $6.3 million capital gain).
Personal exemption. If they do nothing but claim the personal $500,000 personal exemption, they’d expect to pay $2.1 million in taxes (the same tax rate, but on the slightly smaller $5.8 million capital gain after the personal exemption).
CRUT. If they instead used a CRUT, they’d owe no taxes up front, because the trust is a tax-exempt entity.
How would the family come out in each scenario, drawing on those tax savings, where available, and reinvesting the proceeds?
Taking no tax breaks: Total returns of $13.2 million
Personal exemption: $14.4 million (9% higher, after reinvesting the small tax savings)
NIMCRUT: $21.9 million (66% higher, after reinvesting the larger tax savings and donating a portion to charity, consistent with the trust’s rules)
After 50 years (the expected length of the trust based on IRS estimates), Austin and his family would expect to end up with about $21.9 million in total payouts, or 52% more than if they had just taken advantage of the personal exemption!
In other words, by leveraging a CRUT, Austin and his family are able to pocket an extra $7.5 million. In addition, they will create an additional $15 million that they will use — consistent with the CRUT’s charitable mandate — to support causes they believe in via their family foundation or donor advised fund.
For investors looking to sell their appreciated assets, a Charitable Remainder Trust can be a great tax advantaged option that can benefit the individual, future generations, and important charitable causes.
- See our next article on the different tax opportunities for real estate.
- Schedule a time to chat with our team or get started setting up your trust (at no cost and with no commitment)
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