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Monday, April 29, 2024
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Case Studies |
Double Discounting Through a Lead Trust and LLC
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Case:
Barry and Tracy Fletcher, both age 55, own farmland inherited from Tracy's grandfather five years ago. At that time, the farmland was valued at $1.5 million and, therefore, this is their cost basis in the property. The current fair market value of the land is $2.5 million. The land is free and clear, and the property is leased at an annual rental of $150,000 to a local farm corporation under a 15-year lease. There are 10 years remaining on the original lease agreement. The land is now directly in the path of development. In fact, the Fletchers have been approached by a number of developers to sell the property, with a recent cash offer coming in at $2.5 million. They have made the decision, however, not to sell, knowing that the property can only increase in value over the term of the lease. According to some estimates, the farmland may be worth as much as $10 million in the next 10 years.
Question:
Barry and Tracy would like to transfer the property to their children and make a $1.5 million gift to charity. Is there some method whereby they can accomplish both of these objectives?
Solution:
Barry and Tracy decided to discuss this problem with their good friend, Patti Stevens, who is the Major Gifts Director with a charity raising funds for a major building project. Ms. Stevens is also an attorney who worked for 10 years in estate planning. After listening to their concerns, she stated that there is a very creative way to accomplish the objectives.
Barry and Tracy would establish a limited liability company (LLC) and contribute the farmland to the LLC. They would be designated as the only managers of the LLC and, therefore, would retain total control over all decisions with respect to the property. At the time they contribute the property to the LLC, Barry and Tracy will obtain a formal appraisal of the farmland, which is expected to appraise for $2.5 million. Then a second business valuation appraisal would be obtained to value the membership interests in the LLC. This second appraisal would be expected to establish a rather conservative valuation discount of 35% for the interests in the LLC.
Immediately following completion of the business valuation appraisal, Barry and Tracy would make a gift of 99% of the LLC interests to a charitable lead annuity trust. The discounted value of the interests is $1,625,000, based on the valuation discount of 35%. The charitable lead trust will be for a term of 10 years and will pay $150,000 per year to the charity. Therefore, the payout rate on the lead trust will be 9.23% ($150,000/$1,625,000). At the termination of the trust in 10 years, the farmland will be transferred to their three children.
As a result of funding the lead trust with the farmland, Barry and Tracy will receive the second discount - a charitable gift tax deduction of $1,136,000 (based upon an Applicable Federal Rate of 5.4%). Therefore, the net taxable transfer to the children for gift tax purposes is only $489,000 ($1,625,000 - $1,136,000). Barry and Tracy would utilize only a minor portion of their lifetime exemptions when filing Form 709, but ultimately an estimated $10 million in property value could be transferred to the children completely free of any additional gift or estate tax cost. Last, since $150,000 will be paid to the charity for a period of 10 years, their objective to make a gift of $1.5 million to the charity is fulfilled. Therefore, by using the LLC in combination with the lead trust, a double discount is achieved for gift tax purposes. The final result: substantial value is transferred on to family members and a sizable gift to charity is realized.
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