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Thursday May 24, 2018

Case of the Week

Exit Strategies for Real Estate Investors, Part 14

Case:

Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. By far, Karl was most successful with real estate investments. It was definitely his passion.

Amazingly, Karl continued to buy and sell real estate at the age of 85. For instance, about three months ago, Karl discovered a great investment property. It was a "fixer-upper" commercial building in a great area. While other nearby buildings sold for over $2 million, the seller needed to sell quickly and was asking just $1 million.

The condition of the building turned many buyers away. It was being sold "as-is," but Karl was not deterred. He could see great potential with the building and knew it would not take much to get it to market condition. Therefore, Karl swooped in, bought the building for $1 million and instantly hired contractors to refurbish the place.

After three months of hard work refurbishing the building, the place looked like new! In the end, Karl had invested $250,000 in the building, bringing his total investment in the property to $1.25 million. One month after the completion of the work, Karl was contacted informally by a company that expressed an interest in the building — a $2 million interest! This was no surprise to Karl. He knew the building was another great buy.

After Karl learned about the benefits of a FLIP CRUT, he eagerly wanted to move forward. (See Parts 1 and 2 for a full discussion of this decision.) It looked like the perfect solution. However, Karl did have one complaint about the FLIP CRUT solution. Because CRUT payouts are recalculated each year based upon the January 1 value of the trust, there is an element of uncertainty associated with the future income stream. In short, Karl's payouts could go up and down.

Question:

Instead, Karl would love to have a set, annuity type of payout each year. Can Karl fund a charitable remainder annuity trust (CRAT) with his building? Which is better for Karl — a CRAT or FLIP CRUT?

Solution:

A charitable remainder unitrust (CRUT) is an excellent option for donors with appreciated real estate. A CRUT provides a charitable tax deduction, an income stream and a tax-free sale of the real estate. This tax-free sale of the real estate inside the trust allows the trustee to reinvest the full sale proceeds (i.e., investment diversification without payment of any capital gains tax).

Because of the unmarketable nature of real estate, advisors usually recommend a NIMCRUT or FLIP CRUT. With either of these types of CRUTs, the trustee is not forced to make a trust distribution unless there is actual trust income. For this reason, a standard CRUT or CRAT is generally not recommended when real estate is the only trust property. Both of these types of trusts require trust distributions, irrespective of actual trust income. If the trustee does not make the required distributions, the trustee runs the risk of disqualifying the trust and subjecting the trustee to tax penalties.

While Karl's building is likely to sell quickly, there is no guarantee. Therefore, it is not prudent to create a CRAT, given the risk associated with the sale process. However, if Karl is willing to transfer a substantial amount of cash and/or stocks (in addition to the building) into the CRAT, it might work nicely. The infusion of cash or stocks into the CRAT provides the trustee with the necessary funds to make trust payments and, thus, avoid missing any mandatory payments. It is extremely important that Karl transfer the cash or stocks into the CRAT at the same time as the building transfer. Because CRATs do not allow for additional contributions, Karl could not contribute cash or stock at a later date.

Based upon his desire to enjoy a fixed annuity payout, Karl elects to transfer the building and $500,000 of appreciated stocks into the CRAT. This arrangement provides for substantial liquidity to the trust. Furthermore, when the building sells for $2 million, the lack of marketability issue will disappear. In the end, Karl loves the CRAT solution because he knows that his annuity stream will never change, and he diversified a large block of his appreciated stocks.

Editor's Note: This case study illustrates that a CRAT, in limited circumstances, can work smoothly even though an unmarketable asset is inside the trust. However, in most situations, a FLIP CRUT or NIMCRUT would be more advisable, given the great flexibility associated with those types of trusts. Before funding a CRAT with unmarketable property, it is highly suggested that one consult with a competent tax advisor.

Published May 18, 2018
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Previous Articles

Exit Strategies for Real Estate Investors, Part 13

Exit Strategies for Real Estate Investors, Part 12

Exit Strategies for Real Estate Investors, Part 11

Exit Strategies for Real Estate Investors, Part 10

Exit Strategies for Real Estate Investors, Part 9

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Shelby Harder, 2018
Dr. Irving Auld and Dorothy
Roher Auld Scholarship

"Many students take for granted what a university has to offer. However, I am thankful every single day for the opportunity to attend this prestigious school. At Lawrence, you have the ability to engage in Socratic debates about the world we live in at dinner, play recreational or NCAA sports, and talk one on one with brilliant professors. At Lawrence, you don't just 'learn' a subject, you are immersed in it. You dive into the liberal arts and these professors show you the beauty in it all, and how everything is tied together. I am a Biochemistry major with a soft spot for rocket science, philosophy, and evolution. Lawrence is my dream school, and it would have never been possible without the Dr. Irving Auld and Dorothy Roher Auld Scholarship. I am forever grateful for their generosity."

Juliana E. Olsen-Valdez, 2018
Carroll Family Scholarship

"Lawrence University is a great place for students looking to embrace their multi-interested approach to learning. As a Geology major, I have spent many long hours in laboratories. But, I have also had the opportunity to organize and lead students on outdoor backpacking trips, help build a stronger community for International students, participate in dialogues on campus initiatives, attend dozens of musical events, and study abroad in a field-based geology program, all while taking classes in a variety of academic spheres on campus. Lawrence, as an institution and student body, creates a collective of learners, listeners, and leaders who are continuously evolving their understanding of the world around them. I am fortunate to have the support of the Carroll Family Scholarship, so that I can say I am a part of this exceptional community too!"

Weiqi "Vicky" Liang, 2019
Marian H. Cuff Endowed Scholarship

"Lawrence is a special institution with nice people around the campus. I better myself by trying out different things and using new ways to think critically. Even though I am a Philosophy major, I have successfully taken classes in Anthropology, Biology, Economics, and Government. In addition, I still find many great extracurricular opportunities to explore, such as singing with Viking Chorale, even though I am not a music major. While having the great experience of volunteering at the elderly center last year, I became an elder advocacy coordinator at the Volunteer Community Service Center. At Lawrence, I've learned to handle difficult academic problems while looking forward to exploring possible opportunities. I am very grateful to be awarded the Marian H. Cuff Endowed Scholarship for every year I have been here, and appreciate that the scholarship has provided this wonderful Lawrence experience to me."

Anthony Cardella, 2018
Ansorge Family Scholarship

"I am so excited that I am able to attend Lawrence University. I know that I will make great progress studying piano with Dr. Michael Mizrahi. Since being at Lawrence I've already made a lot of progress and I really love it here. I am so grateful for the Ansorge Family Scholarship that made it possible for me to come to Lawrence because without it, I might not have been able to afford the cost of attending a school that is a great fit for me and a place where I will learn so much and go so far."

Milwaukee-Downer Scholarships and Professorships

Some of the many recipients of Milwaukee-Downer scholarships gather for a photo with Carolyn King Stephens M-D'62 and Marlene Crupi-Widen M-D'55 in January 2014 at the annual scholarship luncheon.

Rosamund Victoria Bille Adler Scholarship
Dr. Charles E. Albright Scholarship
Helen Daniels Bader Scholarship
James G. and Ethel M. Barber Scholarship
Catharine Beecher Endowed Fund for Downer Women
Bessie A. Bell Scholarship
Berk Scholarship
Frederick C. Best Scholarship
Beta Study Club Scholarship
Lynde Bradley Scholarship
Lucia R. Briggs-Alumnae Scholarship
Edith Lange Brooks Scholarship
Anne Barman Caldwell Scholarship
Alice Miller Chester Scholarship
City of Milwaukee Student Funds Scholarship
Milwaukee-Downer Class of 1940 Fund
Milwaukee-Downer Class of 1942 Fund
College Endowment Association Scholarship
Janet Cope Crawford Scholarship
Jessie Mabbott Daniels Scholarship
F. T. Day Scholarship
Rufus Dodge Scholarship
Julia P. Ely and Hannah R. Vedder Memorial Scholarship
General Endowed Scholarship - M-D College
Dr. Alfred W. and Mrs. Ada F. Gray Scholarship
Berenice E. Hess Scholarship Endowment
Lucille Ray Hibbard Scholarship
Belle Austin Jacobs Scholarship
Helen McDermott Jurack and Ronald J. Mason Scholarship
Marjorie S. Logan Scholarship
Nellie Maxwell Scholarship
S. Annabelle & Paul McGuire Scholarship
Memorial Scholarship Fund - Milwaukee-Downer
Milwaukee-Downer Class of 1953 Scholarship
Milwaukee-Downer Class of 1955 Scholarship
Milwaukee-Downer Class of 1956 Scholarship
Milwaukee-Downer Class of 1957 Scholarship
Milwaukee-Downer Class of 1958 and 1959 50th Reunion Scholarship
Milwaukee-Downer Club Scholarship
Milwaukee-Downer/Lawrence College Consolidation 50th Anniversary Scholarship
Francis Evelyn Kelley Morgan Memorial Scholarship
O'Neill-Anderson Family Scholarship Endowment
Elizabeth A. Olson Scholarship
Gilbert Haven Peirce, Sr. and Emma Elizabeth Manor Peirce Milwaukee-Downer Scholarship
Aleida J. Pieters Scholarship
Matilda Siefert Puelicher Scholarship
Elizabeth Ann Richardson Scholarship
William M. Ross Memorial Scholarship
Elizabeth Rossberg Scholarship
Charles Frederic Sammond Scholarship
Mildred L. Schroeder Scholarship
Sivyer Educational Fund for Women
Marion Merrill Smith Scholarship
Dr. Elizabeth A. Steffen Scholarship
W. Mead and Elizabeth McKone Stillman Scholarship
Strzelczyk Family Scholarship
Clare Scherf Sweetman Scholarship
Raymond H. and Jane K. Taylor Scholarship
Jerline E. Walfoort Memorial Scholarship
Barbara E. Wehr Fund
Harmony Weissbach Scholarship
Martha and Frances Wheelock Scholarship
James G. and Ethel M. Barber Professorship of Theatre and Drama
T. A. Chapman Professorship in Music
Alice G. Chapman Professorship in Physics
Alice G. Chapman Librarianship
Milwaukee-Downer College and College Endowment Association Professorship

Angela Small Fry Intia, 2019
Maurine Campbell Scholarship

"Thanks to the Maurine Campbell scholarship, I have been able to attend the amazing school that is Lawrence University. With the help from this scholarship, I have been able to pursue my dream career in chemistry working with the outstanding and extremely helpful faculty here. Even outside of chemistry I take the time for exploration into my interests and want to give back through my work as a resident life advisor, stock room assistant, and student supervisor at Bon Appetit. Everything I have learned here, academically or not has forever molded the person I am today."

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