Henry & Associates
Malpractice Coverage – IV,
Don’t Leave Home Without It
(fourth in a series on design and implementation issues)
The CRT isnt a suitable tool for all property. While its true that most appreciated assets can be contributed to a §664 charitable remainder trust and sold without incurring an immediate capital gains liability, there are a few problems that will crop up if an advisor isnt careful about what goes in there.
Since my web site offers an on-line CRT income tax deduction calculator, I periodically receive calls from advisors who need to confirm the results of their data entries. One such call was from a brokers assistant needing an answer for her employer who was driving over to present a solution to a prospective client. The donor had a highly appreciated asset and was considering the use of a charitable trust. I was told the assets fair market value was $3 million and that the client was 66 years old and the broker had proposed a one life CRUT. He wanted to know what the highest payout allowed would be for that type of gift. I responded that it depended on the asset, the charity, the date of the gift and the appraisal. The brokers assistant had calculated a $1 million dollar deduction, but she wanted to make sure she hadnt overlooked anything. She further indicated that the asset had a $100,000 basis with significant unrealized gain so the broker was attempting to earn the prospects business by displaying his tax-planning prowess. I asked exactly which asset was to fund the trust and was told it was art. The brokers putative plan was to have the artwork contributed to the CRT and have the charity pay the client 10% of the value annually while the donor continued to display the contributed asset in her home.
Where to start dissecting the problems in this case?
There were so many mistakes and assumptions that had to be corrected that the assistant actually put me on hold in order to intercept the broker before he arrived at the prospects home. The first problem was the contribution of art to a CRT. While tangible property is an allowable contribution [Sec. 170(e)(1)(B)(i)], it wont produce the tax deduction this donor expected. Deductions hinge on related use. For example, art given to a museum or an educational institution with an art history program can be contributed and generate a fair market value (FMV) income tax deduction if it is related to the purpose for which the organization was granted exempt status. A CRT has no related use; contributed assets are there to be sold, not exhibited or used. As a result, this prospects income tax deduction is reduced from fair market value to basis, and any tax deduction remains unavailable to the donor until after the asset is actually sold by the charitable remainder trust. This news further upset the broker, and then when I informed him that there wasnt any way a CRT would have any funds with which to pay out the overgenerous income distribution until the artwork was actually sold, it completely blew his deal out of the water. He had assumed that the donor would be allowed to keep the artwork displayed in her home and that the charitable remainderman would provide the liquidity for the needed income. The donor had little philanthropic motivation and the broker only hoped to manage funds he thought the charity would advance to his clients trust. Clearly, this isnt a CRT headed towards successful implementation.
This remarkably inept CRT proposal was further distinguished by having the dealer who sold the client her artwork serve as the appraiser. Generally, a qualified appraiser is a term that specifically excludes the seller of the donated asset, the donor, the donee, and any related individuals or employees of these disqualified parties. Additionally, there is a requirement for independent authorities to hold themselves out to the public as appraisers in order to complete the IRS form 8283 and substantiate the values claimed for the contributed asset if the value is greater $5,000.[Treas Reg §1.170A-13(c)1]
What assets generally work best inside a charitable remainder trust?
- Unrestricted appreciated public stock
- Appreciated mutual funds
- Marketable and unencumbered real estate
With special handling, these assets may be manipulated so they can be made to eventually work inside a CRT.
- Encumbered real estate
- Closely held C corporation stock
- Tangible personal property, including art
- Restricted (Rule 144) stock
- Stock with a tender offer in place
- Sole proprietorships – ongoing businesses
- S corporation stock
Some gifts are just doomed as possible contributed assets for CRT use, and generally should be avoided.
- Property with an existing sales agreement
- Installment notes
- Stock Options (ISO and NQSO)
- Inter-vivos transfers of IRA/Qualified Plan
- Inter-vivos transfers of deferred annuities
- Inter-vivos transfers savings bonds
Henry & Associates
22 Hyde Park Place, Springfield, IL 62703-5314
217.529.1958 — 217.529.1959 telefax
800.879.2098 toll-free — VWHenry@AOL.com
© 2001 http://gift-estate.com
Vaughn W. Henry
Gift and Estate Planning Services
22 Hyde Park Place
Springfield, IL 62703 USA
Phone: (217) 529-1958 Fax: (217)529-1959
Toll-free: (800) 879-2098
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.