Attorney Richard Abbondanza at North Yarmouth Academy, where he serves on the board of trustees. Photo: Thalassa Raasch/MaineCF

Portland attorney Rick Abbondanza discusses how gifts to charity can help real estate clients manage income taxes.

MaineCF: What provisions in the Tax Cuts and Jobs Act of 2017 will work well for your clients?
Rick Abbondanza: We work with a lot of clients who own investment real estate so I was very pleased to see that the new tax law retained two important provisions that allow these clients to strategically manage their income taxes: the 1031 tax-deferred exchange and the charitable deduction.

MaineCF: What is a 1031 tax-deferred exchange and how does it benefit your real estate clients?
Abbondanza: Section 1031 of the Internal Revenue Code (IRC) allows a taxpayer who is holding property for investment to sell the property and reinvest the entire net proceeds in another investment property without paying capital gains tax on the appreciation of the original property. Strict IRC requirements must be met to qualify for this special tax deferral treatment. However, when met, this can be very financially beneficial for the client.

MaineCF: You mentioned that the 1031 exchange is a tax-deferral strategy. When does the client pay the tax on appreciation?
Abbondanza: If a client dies owning the last replacement property, the estate gets a step-up in basis to the appraised value on the client’s date of death. In that case, it is possible that no income taxes would be due. However, many of our clients reach a time in life when they no longer want to manage their property, do not have the same risk tolerance for the real estate market, or just want to take some of their dollars off the table and have more liquidity. At the time of this sale they would typically have to recognize the capital gains unless they have another strategy to reduce the tax.

MaineCF: How does the charitable deduction benefit your real estate investment clients?
Abbondanza: One way charitably minded real estate clients can reduce their income taxes is to gift their real estate to a charitable remainder trust (CRT). This strategy works well for clients who want to reduce their income taxes, retain enough income to live comfortably, and benefit the charitable organization(s) that they care about in the future. The CRT can be used as an exit strategy from a 1031 exchange or instead of a 1031 exchange. 

MaineCF: How does a charitable remainder trust work?
Abbondanza: A charitable remainder trust is an irrevocable trust that provides an annual income stream to the donor client (and possibly others) for life or a set term of up to 20 years, with the remaining funds at the end of the term being distributed to the client’s favorite charitable organization(s). The client receives a charitable income tax deduction for the present value of the remaining funds that will pass to charity (subject to some limitations) at the time the property is transferred to the CRT. When the trustee sells the real estate to create liquidity or diversify the investment, neither the client nor the trustee pays income tax on the appreciation because of the CRT’s tax-exempt status. The income recipient only pays income taxes on the income distributed to them each year.

With any of the strategies we have discussed, it is important for professional advisors to begin the conversations early before there is a purchase and sale contract in place, and to be sure to review the strict provisions of the Internal Revenue Code.

Richard J. Abbondanza is a partner in the Portland law firm of Hopkinson & Abbondanza. He regularly speaks on the subjects of estate planning, retirement planning, and real estate and business succession planning. He is admitted to practice in all Maine courts and is a member of the Maine Estate Planning Council and WealthCounsel, a national association of estate planning attorneys and advisors.