By Kathryn A. Walson
You've just received another fund-raising letter from your alma mater. Usually you write a check, but there's a good chance your college is proposing something called a "retained life estate." So what is that, and is it worth pursuing?
With a retained life estate, you give your house, vacation home or farm to a college. You get an income-tax deduction the same year, and you and your spouse can live in the residence until you both die. At that point, the university assumes control.
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Cornell University has arranged ten life estates in the past five years. "It's something we don't benefit from for a period of time," says Jack Murphy, senior trust officer at Cornell, in Ithaca, N.Y. "But it's still a very good gift. We know it's coming."
Although donors don't frequently opt for retained life estates, those who do can reap substantial tax benefits. It could be the way to give if you need a large tax deduction in a particular year -- perhaps to offset a one-time windfall that could push you into a higher tax bracket. And the donation removes the house from your taxable estate. Bequeathing the house at your death would also get the house out of your taxable estate, but you would not get an income-tax deduction while you were alive.
Impact of Giving
Donating your house to charity means, of course, that your heirs won't inherit the property. This approach may appeal to donors who are childless or whose children don't need or want the property. "They may be well established, or they may not be interested in taking on the burden and expenses," says Caroline Camougis, managing director of Delphi Partners, a New York company that advises individuals and institutions on charitable giving. (In addition to colleges, many charities also arrange for retained life estates.)
The tax deduction you receive is based on a number of factors, including the market value of the property and your life expectancy. The IRS has a formula to figure the deductible amount based on how far in the future the gift is likely to be consummated.
That means the older the donor, the bigger the deduction. For a house with a market value of $300,000, for example, a 40-year-old could take a $25,602 charitable income-tax deduction, compared with a $122,009 deduction for a 70-year-old donor.
In some circumstances, you can also save on capital-gains taxes. If you were to sell your house, you and your spouse would pay a 15% long-term capital-gains tax on any profit above $500,000 (if you're single, $250,000). If you enter into a life-estate agreement, you would not pay capital-gains tax.
Despite the advantages, keep in mind that a retained life estate is irrevocable. You can't change your mind and leave the house to the kids. "It is not something that you would enter into lightly," says Marianne Piepenburg, assistant vice-president for planned and endowment giving at Southern Methodist University, in Dallas.
In most cases, you'll continue to pay property taxes and insurance and handle repairs. "The university isn't going to mow your lawn or clean your gutters," says B. John Readey III, an estate-planning lawyer in Bryan Cave's Kansas City, Mo., office.
Colleges accept property that's located close to campus or even across the U.S. They tend to look for high-value homes without mortgages. For example, Cornell favors property that's worth at least $250,000, Murphy says. If your home appreciates in value after you donate it, your alma mater, not you, will benefit from the increase.
When the donor dies, the college typically sells the home to collect its worth. In cases where the home is located near campus, an institution may decide to use the property rather than sell it.
Because the agreement is binding, a retained life estate is not a good option for homeowners who may need money from the house later on to pay for retirement, a nursing home or a smaller home. Make sure you have sufficient assets set aside before you enter such an agreement.
This article was originally published in the July 2007 issue of Kiplinger's Retirement Report.
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