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Real estate owners find haven in pooled-income fund

New vehicle aimed at property owners with charitable intent

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By Janet Morrissey

September 22, 2008 6:01 am ET

A number of broker-dealers have started offering a program that allows charity-minded clients to offload their real estate in a tax-friendly way while enjoying an income stream from the proceeds.

The program, offered since June by Life Income Funds of America in Englewood, Colo., is a pooled-income fund that allows real estate donations.

About 25 broker-dealers sell the program, including Commonwealth Financial Network of Waltham, Mass.

"It's almost a daily occurrence where I receive a call from an adviser who has a client who has real estate holdings and is trying to figure out what they want to do with them," said Gavin Morrissey, director of advance planning in Commonwealth's San Diego office.

"I'm not saying this is the solution for every single client, but it's at least another option from just an outright [property] sale, a 1031 [like-kind exchange] or a charitable-remainder trust," he said.

At Omni Brokerage Inc., a broker-dealer in Salt Lake City that specializes in real estate and sells the program, president Greg Paul said he's seen a surge in the number of clients seeking advice on ways to divest their real estate holdings, especially in light of the credit crunch and the anticipated increase in the capital gains tax rate.

DEMAND FROM ADVISERS

Mark Quam, president and chief executive of Life Income and its distributor, Welton Street Investments LLC, also of Englewood, said the firm is responding to an increase in demand from financial advisers and broker-dealers whose clients were looking for options for their real estate holdings.

"Demand is extremely high, especially with their baby boomer clients," he said. "[Baby boomers] typically have 30% to 40% of their net worth in real estate and only 15% to 25% in investments such as stocks, bonds, mutual funds, 401(k)s and things."

Life Income's product is intended for retirees and others who want monthly income but no longer want to manage their real estate holdings or face a capital gains tax from selling the properties.

"They don't want the tax implications of selling a property or the management hassles of putting it into a 1031 exchange program," Mr. Quam said.

Under his firm's program, a person can donate cash, securities and real estate to a pooled-income fund, which then sells the property and reinvests the proceeds in special funds. The donor gets a partial tax deduction for charity, avoids paying the capital gains tax from the property sale and gets a monthly or quarterly income distribution from the fund — which varies depending on the fund's performance — until the donor dies.

Under one option, after the donor's death, the remaining principle is donated to the philanthropist's charity.

The donor also has another option of donating all or even part of the property to the charitable fund and can designate up to two heirs to continue receiving monthly income payments after the donor's death.

There are other donor programs, such as the charitable-remainder trust, charitable-lead trust and the charitable-annuity trust, which often accept real estate donations as well. However, these trust programs are donor-advised funds that require costly lawyers and accountants to set up and maintain.

Also, many of these trusts re-quire significantly higher minimum donations, such as Boston-based Fidelity Investments, which has a $250,000 minimum in its charitable-remainder trusts, as opposed to the Life Income Funds' pooled-income fund, which accepts donations as low as $20,000 for securities and $150,000 for real estate.

Pooled-income funds also allow people to contribute a portion of a real estate property, while charitable trusts require that the entire property be donated.

"Charitable-remainder trusts are very expensive and cumbersome — lawyers and trustees are involved," Mr. Quam said.

Pooled-income funds eliminate the "expense and administrative hassles that come along with a charitable-remainder trust," Mr. Morrissey said.

Donors can direct their assets into one or more of Life Income's four funds, which currently offer yields ranging from 1.7% to 8.9%, he said.

The best candidates are those who don't have more than 50% debt on their properties, Mr. Quam said.

COST OF GIVING

Still, there are fees associated with a pooled-income fund, which vary from firm to firm. At Life In-come, the donor faces a 4% upfront fee and a 0.25% annual fee for five years in the firm's Series A funds, and a 2% upfront fee and a 0.5% annual fee for seven years in Series C Funds.

In addition, donors get hit with a 1.05% annual asset management and trustee fee.

The Fidelity Charitable Gift Fund doesn't charge an upfront fee for its pooled-income fund, but it allows real estate donations only on a "case-by-case" basis and offers only one fund in which to invest the proceeds. It charges as much as 0.5 percent a year in administrative fees, depending on the amount donated into the fund, according to a Fidelity executive, who asked not to be identified.

Most other pooled-income funds don't accept real estate donations — at least not yet.

"The complexity of owning real estate and the risks associated with it, and problems associated with disposing of real estate — even in good times" — makes it a tricky investment for a charity, said Dave Ness, president of the Raymond James Charitable Endowment Fund in St. Petersburg, Fla., whose pooled-income funds don't allow real estate donations. "And the current real estate environment hasn't made disposing real estate any easier," he said.

Another firm, which did not wish to be identified, said it doesn't accept real estate donations, because managing and selling real estate could significantly increase costs and therefore lower the fund's yield for all of the other fund's donors.

E-mail Janet Morrissey at jmorrissey@investmentnews.com.

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