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Sunday, April 28, 2024
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Case Studies |
The Dirtiest CRT Ever Created, Part 1 of 2
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Case:
Sam Morello, 50, has been in the mining business for some 30 years. His company, Hard Hat Drillers, a sole proprietorship, owns and operates several mines in the northeast part of the country. The company's sole source of revenue is from its mining efforts. However, a national landscaping company has made Sam an offer to buy his entire surplus of dirt for $100,000. There has not yet been any contract or other formal agreement between the two parties. In total, Sam estimates that he has about 12,000 tons of dirt.
At the same time Sam was considering the offer, he attended a financial planning seminar where he learned about charitable remainder trusts (CRTs) as supplemental retirement vehicles. In particular, Sam liked the idea of deferred income and tax-free growth because he was currently "maxing" out his IRA each year. Therefore, the following week, Sam contacted his attorney about using his dirt to fund a CRT.
Question:
Will Sam's dirt contributed to a CRT provide Sam with the benefits he is looking for? What issues does he face with this plan?
Solution:
Sam's dirt will be considered tangible personal property because it has been extracted from the ground. In other words, it is no longer real property, since it has been severed from the land. As a general rule, gifts of tangible personal property produce a charitable contribution deduction equal to the donor's cost basis in the property. See Sec. 170(e)(1)(B). While there is a limited exception to this rule ("related use" exception), gifts of tangible personal property to a unitrust generally do not fall within the exception. See Reg. 1.170A-4(b)(3). Consequently, Sam's transfer of his dirt to a CRT would be deemed an unrelated use. As a result, his deduction would be based upon his cost basis in the dirt, which is zero, since he expensed costs associated with the removal of the dirt.
Despite providing no charitable tax deduction, Sam's CRT, which would be drafted with either a net income with makeup or flip provision, still meets his two primary goals of deferred income and tax-free growth. After Sam transfers the dirt to the CRT, the trust would sell the dirt to the landscape company and then reinvest for growth with little, if any, yearly income. After many years of tax-free growth, the trust could be invested for income to provide yearly retirement income to Sam. This result pleases Sam immensely, and as a result, he funds his CRT with 12,000 tons of his dirt.
Editor's Note: In Part 2, we look at what if Sam gave the "rights" to the dirt to his CRT. In other words, how does the result differ if another party, not Sam, extracts the dirt from the ground?
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