Wills, Trusts & Estates Prof Blog

Editor: Gerry W. Beyer
Texas Tech Univ. School of Law

Tuesday, January 31, 2012

Case Study on How Real Estate Investors Can Utilize FLIP CRUTs

Trust blocksGift Law Pro recently posted a case study entitled, Exit Strategies for Real Estate Investors, Part 1, Jan. 30, 2012. The case study details how real estate investors can utilize FLIP CRUTs during the property selling process. The case study is posted below, in full:

Case

Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turn 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 4 months which meant the gain from the sale would be short-term capital gain. In other words, the applicable tax rate would be 35%, not 15%. Karl cringed at the thought of paying a third of his gain to the government. At the same time, Karl knew the real estate market could change directions in the next year. So, although Karl wanted the 15% tax rate, Karl did not want to risk holding the property another 8 months.

Question

Can Karl sell the building and bypass the tax on the sale of the property? Karl wants to reinvest the full sale proceeds in an income-producing investment. Is this possible?

Solution

Based upon Karl's situation and goals, a FLIP CRUT is an excellent option. Prior to any binding sale agreement, Karl could transfer his property into the FLIP CRUT. In this case, the potential buyer merely expressed an interest in the property. Because there is no legally binding agreement between Karl and any buyer, there is no prearranged sale problem.

Once the property is transferred into the FLIP CRUT, the trust would list and sell the property. Even if the property sold for $2 million, the trust would owe no taxes on the sale because the trust would be exempt from income taxes. Therefore, the FLIP CRUT would meet Karl's first goal – avoiding an immediate one-third bite out of his short-term capital gain.

Next, the trust would reinvest the full sales proceeds of $2 million (minus selling costs). Pursuant to Karl's goals, the trust would likely invest for income. It could invest in bonds, dividend paying stocks or even rental property. This meets Karl's second goal.

So far, Karl is very pleased with the FLIP CRUT option. It looks like the perfect solution. However, there are two potential downsides to this plan. The two remaining issues are as follows: 1) What would be the charitable income tax deduction for gifts of short-term capital gain property? and 2) What would be the tax characteristics of the FLIP CRUT payouts to Karl?

Exit Strategies for Real Estate Investors, Part 1, Gift Law Pro, Jan. 30, 2012.

https://lawprofessors.typepad.com/trusts_estates_prof/2012/01/case-study-on-how-real-estate-investors-can-utilize-flip-cruts.html

Estate Planning - Generally, Trusts | Permalink

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Comments

Is there a minimum property value requirement? Is this option available in Illinois?

Posted by: Doug Perry | Jan 31, 2012 2:43:06 PM

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