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Thursday, May 2, 2024
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Case Studies |
A Runner's C Corporation, Part 1
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Case:
Rob Hansen, 65, runs The Shoe Factory, Inc., which is located in Boise, Idaho. The Shoe Factory is actually a building where national shoe companies come to manufacture their product. It is an enormous 50,000 square foot, high tech facility designed specifically to accommodate shoe production. Accordingly, Rob's company leases the space to clients interested in such a facility. Rob has operated the business successfully for over 35 years and has put in many long hard hours during that time. Therefore, at the age of 65, he is ready to retire and enjoy the fruits of his labor.
Hearing of Rob's intentions to retire, several shoe companies have inquired about purchasing The Shoe Factory from him. Specifically, they want to purchase the manufacturing facility as opposed to the C corporation itself. (Ed. This is a typical desire of a new buyer because they wish to take new depreciation on the property and do not want to inherit any liability concerns associated with the corporation.)
The Shoe Factory owns one primary asset - the building and land, which is valued at $10,000,000 and has no debt. The Shoe Factory had depreciated the building over the past 30 years, so its current cost basis is now $1,000,000. Rob realizes that if his company sells the building it will realize $9,000,000 of gain. The $9,000,000 would be taxed at corporate tax rates, which could be as high as 34%.
Question:
Rob cringes at the thought of losing a third of his equity to the government. Rob inquires with his attorney about his options. Specifically, he wants to minimize any tax on the sale of the Shoe Factory, and he wants sufficient funds for his retirement. What can his attorney suggest to solve his dilemma?
Solution:
Rob's attorney suggests using a Corporate Charitable Remainder Unitrust with a 7% payout. The Shoe Factory, Inc. - the donor - could transfer the property into the CRUT and receive a charitable income tax deduction for doing so. Then, the trustee of the CRUT could sell the property tax-free and reinvest the proceeds in a balanced portfolio. The CRUT would then make payments each year to the corporation, which Rob could withdraw as salary.
While seemingly a perfect solution thus far, Rob's attorney notes that there will be some limitations to the plan. First, under Regulation Sec. 1.337(d), a corporation cannot put "substantially all" of its assets into a CRUT. Therefore, The Shoe Factory can safely transfer 60% of his property into the CRUT and avoid gain on that portion. The remaining 40%, however, will be taxable when sold to a third party. Second, because The Shoe Factory does not have a life expectancy, the CRUT will need to be written for a term of years (i.e., 20 years). This means the trust will last until Rob is 85 instead of the commonly preferred "for life."
Rob compares the charitable plan versus the sell and pay tax plan and decides in favor of the CRUT. He likes that 60% of the capital gains will be bypassed, which amounts to $5,400,000 ($9,000,000 x 60%). He also is comfortable with the CRUT lasting for 20 years. Rob has a very large IRA which he can rely on for years beyond 85. All in all, Rob feels very pleased with the solution provided by his attorney, and, no doubtedly, will stride into his golden years a happy man.
Editor's Note: In Part two, we will discuss how Rob can utilize a CRUT for the proceeds generated from the taxable sale of the facility (i.e., the 40% not transferred into the CRUT).
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