Kelm Financial Services – Example Case

Mr. and Mrs. Smith, ages 67 and 68, are planning to retire within the next 5 years. As part of their estate planning, they had recently sold off several investment real estate holdings. The largest remaining real estate investment was a ranch located near Comfort, Texas, about an hour north of San Antonio. They had purchased the ranch many years earlier for recreational, hunting, and investment value. In recent years, they had begun to lease the ranch to hunters, but the income generated was insufficient and inconsistent. Located in a highly desired Hill County area, the value of the ranch had grown from their original cost of $ 650,000 to a current market value of at least $ 3,000,000.

The Smiths were referred to Kelm Financial Services who – together with the Smiths’ CPA – began the estate planning process by determining the needs of all family members and then reviewing their assets, income, and tax status. As of the time of this writing, the plan is in the process of being implemented with the final step (sale of the ranch) expected to close by the end of 2014.

As a result of the estate planning process, the Smiths clarified their objectives as the following:

1. Sell the ranch at full market value ($ 3M) and avoid the possibility of a forced fire sale in the future.
2. Avoid capital gains tax on the $2.35M gain ($3M – $650K = $2.35M).
3. Implement a strategy that will provide a consistent reliable monthly income of $ 10K per month.
4. Find current tax deductions to offset other income
5. Maximize the inheritance to their children

In order to meet the Smiths’ objectives, Kelm Financial Services coordinated efforts with an estate planning attorney and a CPA to develop and implement a comprehensive estate plan. The following financial strategies were used together to provide a creative solution.

• Charitable Remainder Annuity Trust (CRAT). The ranch was donated to a newly created irrevocable charitable remainder annuity trust designed specifically for the purpose. This avoided capital gains taxes and created an immediate tax deduction. The trust then sold the property and the funds were used to purchase a lifetime annuity for Mr. and Mrs. Smith. When Mr. and Mrs. Smith pass away, the remaining assets in the trust will be made available to the charity.

• Irrevocable Life Insurance Trust (ILIT) An ILIT was created for the benefit of the children and was funded by the tax savings from the avoidance of capital gains. The death benefit of the ILIT (also known as a Wealth Transfer Trust) was designed to “replace” the ranch as an asset in a future inheritance when Mr. and Mrs. Smith pass away. The ILIT also provides the Smiths’ children the benefits of avoiding probate while providing an income tax free death benefit.

Objectives Met: By implementing this solution, each of the objectives was met.

1. Market value. The ranch was donated to the trust at full value, then marketed and sold to a 3rd party. These funds are expected to provide over $3M cash to the trust when the ranch sale closes in Nov 2014.
2. Capital gains. Capital gains taxes were avoided as a result of the charitable contribution. At an estimated rate of 23.8%, the CPA calculated a capital gains tax avoidance of $559,300.
3. Monthly income. The CRAT generates provides an income of $12,500 per month ($150K per year). The extra $2,500 per month above the required $10,000 was partially used to fund the ILIT
4. Tax deductions. The CPA estimated a charitable deduction of $593,970 from the donation of the ranch. The Smiths were able to apply this deduction to offset other income.
5. Inheritance. The death benefit of the ILIT allowed the children to inherit the same amount as they would if the ranch had not been donated to the charitable trust and also to have tax free income.