Including a DAF or Private Foundation in Your Planning – Henry & Associates

Paving over Farmland – Malpractice XII

Keep those tax notes updated.

John and Julia Ramirez have a citrus grove in what is turning into a rapidly growing neighborhood.  They have drawn the unwanted attention of a number of buyers seeking large tracts of agricultural land for its commercial and residential potential.  Additionally, because they possess senior water rights, a nearby city has been pressuring them to sell the rights to develop wells and add capacity to the city’s water system.  Rising property tax rates and increased suburbanization have added further pressure to sell out and move on, especially when they routinely find youngsters prowling around their equipment and getting into mischief.  These liability concerns have forced them reluctantly to accept the inevitable and sell out to commercial developers, and one of their advisors has suggested a charitable remainder annuity trust and a private foundation to minimize the tax hit on the transaction.

Generally, a CRT is a good idea to defer capital gains recognition, especially if the family has charitable inclinations.  However, a CRAT is a poor choice for most real estate sales because of its limitations and rigidity.  A better choice would be a custom drafted unitrust (CRUT) because it offers more flexibility.  Whether they choose a standard CRUT, “FLIP-CRUT”, or a NIMCRUT depends more on the family’s need for control, flexibility and a predictable income stream, as the income tax benefits and basic structure is the same for all three variations of the CRUT. 

Besides recommending the wrong charitable trust, their advisor’s assumptions about using a private foundation as a remainder charity are probably incorrect as well.  Although private foundations previously offered a fair market value income tax deduction for gifts of appreciated assets, after 1998, the rules changed and the more favorable tax treatment is now limited to just cash and appreciated qualified (publicly traded) securities.  If land is used, the income tax deduction is restricted to basis or cost when private foundations are the eventual recipients.  A better choice for tax efficient gifts with hard to value assets like farms, commercial real estate, or residential property would be a CRT with a public charity or, if ongoing family influence is desirable, a donor advised fund inside a community foundation is used instead. 

Why would a donor advised fund be a better choice?  It is simple, easy, and less hassle.  The umbrella charity provides oversight and compliance, spreads the cost of operation over many funds, offers economical management, and still provides for a donor to make recommendations in support of his or her charitable interests.  Many legal and tax commentators routinely suggest the use of a private foundation when contributions exceed $5 million, others suggest that $10 million is more appropriate when families seek to create legacies and provide for ongoing family management.  However, when transferred assets are more modestly valued, then the donor advised fund offers the same immediate tax treatment as that of a public charity with some of the advantages and donor continuity of a private foundation.  Remember to consider all of your options; charitable planning involves irrevocable tools and for this planning to work, articulate specific philanthropic goals.  Too many planners and families allow tax deductions to drive the process instead of treating it as an ancillary benefit.

* closely held stock, commercial real estate, farms or ranches, life insurance policies with cash value, patents, personal residences and vacation homes, retirement plan assets (via beneficiary designation), securities, unimproved property

** art, collectibles or other tangible personal property, equipment or inventory, royalties, copyrights, ordinary income assets

*** Electing “step-down”, uses basis against AGI instead of FMV with 3% itemized deduction reduction rule.

©2003 — Vaughn W. Henry

Vaughn W. Henry

Henry & Associates

CONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO or try your own at Donor Direct Please note — there’s much more to estate and charitable planning than simply running software calculations, but it does give you a chance to see how the calculations affect some of the design considerations. This is not “do it yourself brain surgery”. When is a CRUT superior to a CRAT? Which type of CRT is best used with which assets? Although it may be counter-intuitive, sometimes a lower payout CRUT makes more sense and pays more total income to beneficiaries. Why? When to use a CLUT vs. CLAT and the traps in each lead trust. Which tools work best in which planning scenarios? Check with our office for solutions to this alphabet soup of planned giving tools.