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Wednesday May 22, 2019

Case of the Week

Exit Strategies for Real Estate Investors, Part 7

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 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.

There was one downside to the idea of selling, however. Karl held the property only four months, which meant the gain from the sale would be short-term capital gain. In other words, the applicable tax rate would be 37%, not 23.8%. Karl cringed at the thought of paying much of his gain to the government. At the same time, Karl knew the hot real estate market would not last forever and could change directions in the next year. So, although Karl wanted the 23.8% tax rate, Karl did not want to risk holding the property another eight months.

Karl decided to implement a "Sale and FLIP CRUT" exit strategy (See Case Study Part 6). In other words, he wanted to sell and pay no tax. However, there still was one point of concern.

Karl's advisors noted that once the undivided interest in the property was transferred into the FLIP CRUT, the FLIP CRUT should list and sell the entire property. In short, it would be advisable for the trust to handle the sale of Karl's portion as well.

Question:

Karl wondered why this step was important. Similarly, Karl questioned whether this step was necessary.

Solution:

Although hundreds of split gifts are completed annually and the IRS to date has not contested the concept of split transfers on any of these transactions, it is prudent to evaluate options that increase the safety of prospective transactions. While no strategy short of a private letter ruling for a specific transfer promises 100% safety, several actions may increase safety levels for a split gift. Here are some "Safety Recommendations for Split Gifts."
  1. No Personal Use
    The FLIP CRUT trustee must ensure that Karl does not use the trust property for any personal or private matter.
  2. Independent Trustee
    Split gifts and self-trustees are overly aggressive strategies. In PLR 9114025, the IRS repeatedly emphasized that the "independent trustee acts independently" in order to avoid price manipulation that could increase value received by donors upon sale of their retained interest. Self-trustees who have authority to sell trust assets as trustee and retain assets as owner obviously could manipulate sale terms in a prohibited manner. Independent trusteeship is essential to minimize such potential problems.
  3. Revocable Trust and Unitrust
    An easy method for reducing self-dealing risk is to transfer an undivided interest into a unitrust with an independent trustee and the remaining interest into a revocable trust with that same independent trustee. Donors have rights to income from the unitrust and revocable trust and rights to revoke and recover principal from the revocable trust. However, an independent trustee has both legal title and fiduciary responsibility for both trusts. Given the trustee's ability to control sale terms for both trusts, there is reduced likelihood of a self-dealing violation.
  4. Limited Partnership
    Some conservative attorneys might choose to parallel the fact situation of PLR 9114025 by creating a limited partnership as was done in that ruling. Although undivided interests held in co-ownership would seem to have very similar characteristics to a limited partnership with respect to self-dealing issues, a partnership does indeed fit the specific fact pattern of that ruling.
  5. Partial Sale to Charity
    Finally, one completely avoids the self-dealing issue by selling the partial interest to a public charity prior to funding the unitrust. After sale of part, the donor transfers the balance of the real property to a unitrust.
To answer Karl's questions, there is no requirement that a safety step be used. However, considering the size of the transaction and the benefits at stake, incorporating one or more of the safety steps may prove fruitful should the IRS come calling.

Published May 17, 2019
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Previous Articles

Exit Strategies for Real Estate Investors, Part 6

Exit Strategies for Real Estate Investors, Part 5

Exit Strategies for Real Estate Investors, Part 4

Exit Strategies for Real Estate Investors, Part 3

Exit Strategies for Real Estate Investors, Part 2

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Shelby Harder, 2018
Dr. Irving Auld and Dorothy
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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!"

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Marian H. Cuff Endowed Scholarship

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Ansorge Family Scholarship

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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
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Berk Scholarship
Frederick C. Best Scholarship
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Lucia R. Briggs-Alumnae Scholarship
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Alice Miller Chester Scholarship
City of Milwaukee Student Funds Scholarship
Milwaukee-Downer Class of 1940 Fund
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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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