Farm Property and the CRT
Farm Property and the CRT – A Better Way to Preserve Family Wealth
Although there has been a lot of press about the reduction of the capital gains tax this year, the tendency for most owners of significantly appreciated assets is to hold them, rather than sell and accept any tax liability. Most of us in the estate planning community recognize that anIRC § 664Charitable Remainder Trust offers clients several creative, legal and ethical ways to minimize these tax burdens. Although many financial service professionals promote the CRT as a “capital gains bypass trust”; in reality, the trust offers more than the opportunity to reduce just the capital gains tax. Properly integrated into an estate plan, a CRT can be used to assist family business transition planning and control “social capital” by deciding on a voluntary – self directed gift instead of an involuntary tax overseen by others. Add to those advantages the ability to create a family controlled philanthropy preserving influence benefits of family wealth and you have a dynamic plan. The problem is that we typically approach estate planning processes piecemeal and don’t put together a complete package, one that goes beyond estate planning and actually encompasses wealth preservation planning. A classic case study follows. This IRC§664 Trust deals with creeping suburban sprawl and the conversion of farmland into shopping center parking lots.
John and Betsy Moore, ages 62 and 59, have an 80 acre parcel of ground that has been used primarily for corn and soybean production for their family farm. Recently, they have been offered a price based on a square footage figure for their land, acreage that they bought years ago for $500/acre. Since the Moore’s children are no longer active on the farm, the questions about preserving value and using assets to provide for a retirement have popped up. The Moore’s view this as an opportunity to create retirement security, since neither managed to set aside much in their IRAs. As they reviewed the tax liability with their accountant, he suggested that they call me to run a sample scenario*. Compare what would happen if they kept the land and continued to farm it, or sold it and paid the tax, reinvesting the balance, or transferred it to a CRT. The following chart seems self-explanatory, and they decided it made more sense to utilize the CRT as a retirement and tax planning tool and keep their assets in the community. In this case, they chose to fund a local hospital, a nursing home and a college in a nearby town, rather than let the IRS collect unnecessary tax and have the funds redirected to other non-local causes.
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Moore Farm CRT Strategy (see our sitehttp://members.aol.com/CRTrust/CRT.htmlfor other tools) |
Keep Asset at Work and Pass to Heirs (A) | Sell Asset and Reinvest the Balance (B) | Gift Asset to CRT and Reinvest (C) |
| Fair Market Value of 80 Acres of Development Land |
$800,000 |
$800,000 |
$800,000 |
| Less: Cost of Sale |
$32,000 |
$32,000 |
|
| Adjusted Sales Price |
$768,000 |
$768,000 |
|
| Less: Tax Basis |
$40,000 |
||
| Equals: Gain on Sale |
$728,000 |
||
| Less: Capital Gains Tax (federal and state) |
$218,400 |
||
| Net Amount at Work |
$800,000 |
$549,600 |
$768,000 |
| Annual Return From Asset Valued at $800,000 @ 3.5% (land continues appreciating at 6%) |
$28,000 |
||
| Annual Return From Asset Reinvested in Balanced Acct @ 10% |
$54,960 |
||
| Avg. Annual Return From Asset in 6% CRUT Reinvested @ 10% |
$88,189 |
||
| After-Tax (31%) Spendable Income |
$19,320 |
$37,922 |
$60,850 |
| Statistical Number of Years for Cash Flow for Joint Lives |
31 |
31 |
31 |
| Taxes Saved from $210,016 Deduction at 31% Marginal Rate |
$65,105 |
||
| Tax Savings and Cash Flow over Joint Life Expectancies |
$598,920 |
$1,175,594 |
$1,951,461 |
| Total Increase in Net Cash Flow Compared to Original Asset |
$576,674 |
$1,352,541 |
|
| Value of Assets After Estate Tax (at 55%) Paid |
$2,678,764 |
$302,280 |
$0 |
| Value of Charitable Remainder to Family Sponsored Charity |
$2,590,566 |
||
| Optional Use of Wealth Replacement Trust (WRT) to Offset Gift** |
$3,968,815 |
||
| Total Value to Family (Income and Heirs’ Inheritance)*** |
$3,327,684 |
$1,477,874 |
$5,144,409 |
Hypothetical evaluations are provided as a professional courtesy to members of the estate planning community. Feel free to call for suggestions.
** Insurance premium of $25,028 for duration of joint life expectancy was used so there would be no difference between options B and C in the net cash flow ($775,867 was removed from option C cash flow to fund WRT). Policy used was a variable universal type survivor life policy with investment options at 10% like alternative investment assumptions. Funded with Crummey gifts to ILIT. All investment returns are hypothetical with no guarantee of future performance.
*** Value to family does not include the appreciated value of the charitable gift to family philanthropic interests.
© 1997, Henry & Associates, Springfield, Illinois
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