Funding a Chair with Depreciated Property
Case:
Jonathan and Brenda Williamson have owned a warehouse that they have leased to their family corporation over the last 25 years. The warehouse is currently valued at $1,000,000, is free and clear of debt and is now fully depreciated. Their cost basis is $50,000, which in essence represents the value of the land. Jonathan and Brenda have transferred the bulk of the ownership of the corporation to their children, utilizing a family limited partnership. The lease to the corporation is a "net-net-net" lease that pays Mr. and Mrs. Williamson $71,000 per year. This amount represents approximately 50% of their annual income and it's important that this income continue in evaluating various planning alternatives.The Williamsons have contemplated selling the warehouse to the children, but are concerned about the capital gains taxes. The children are very interested in purchasing the warehouse and then leasing it to the corporation. Upon purchase, the children's depreciable basis would be "stepped up" to $1,000,000 and, therefore, the property could be depreciated a second time within the family.
Mr. and Mrs. Williamson have made periodic gifts to their alma mater over the years and are interested in funding a chair at the College of Business. They thought of funding the chair through a testamentary gift, but their real desire is to guarantee its funding during their lifetimes. Instead of waiting until their passing, they would have a great deal of satisfaction during their lifetimes by knowing that they had ensured the chair's funding.
Question:
Is there a method whereby the warehouse could be used as the funding vehicle for the business chair with the important consideration being that their annual income not be diminished?Solution:
In meeting with the gift and estate planning department at their alma mater, the Williamsons decided to establish a charitable gift annuity with the warehouse. Based on their ages of 85, American Council on Gift Annuities rate to Mr. and Mrs. Williamson will be 7.3%. Therefore, they will receive the desired $73,000 per year based upon an appraised fair market value of $1,000,000. Once the property is transferred to the university, it will be sold to the children who will in turn, lease the warehouse to the corporation. Prior to the transfer of the warehouse to the charity, there will be no signed documentation between the Williamsons and their children (or the charity) in order not to run afoul of the prearranged sale rules.Jonathan and Brenda are very excited about the results. They will receive $73,000 per year the rest of their lives. Of that $73,000, $17,082 will be taxed as ordinary income, $53,097 will be taxed under favorable capital gains rates and $2,821 will be tax free. When they owned the warehouse, the entire $73,000 was taxed as ordinary income and, therefore, they will experience a considerable reduction each year to their tax bill. In addition, they will receive an income tax deduction of $469,035, which will result in substantial tax savings. And last, they will no longer have to concern themselves with the maintenance and upkeep of the building!
The Williamsons are extremely pleased as they have guaranteed their chair will be established. Finally, the children are pleased that they can take advantage of the depreciation deductions in the future based on their cost basis of $1,000,000. Therefore, in essence, the building will be depreciated twice within the same family - first by the parents and then by the children.
Caveat: Could this same transaction have been done utilizing a charitable remainder trust instead of a gift annuity? The answer is "no," since selling the property to the children would then violate the self-dealing rules under Internal Revenue Code Sec. 4941.