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Saturday, May 4, 2024
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Case Studies |
The Artful Unitrust
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Case:
Billy "Boots" Belton has loved the west his entire life. He was born in California, but moved to the wide-open spaces of western New Mexico. During his youth, Boots studied art at a large art institute in California, but the call of the big sky led him back to his beloved western New Mexico.
Boots was a very gifted artist. He combined his love of art with the culture of the west and began painting cowboys and Western scenes. However, he soon found his greatest gift. Boots discovered that his best paintings were of the Indian elders and chiefs.
Through the use of brilliant colors, Boots could capture the character and courage in the weathered faces of the Navajo and Hopi elders and chiefs. He painted every morning from 7:00 a.m. until 12:00 noon and then rode his favorite horse, Paintbrush, across the ranch each afternoon.
While Boots would occasionally sell his paintings, he gradually acquired a larger and larger collection. Boots' paintings sold in the best Western art galleries in Arizona and California. Many Western art lovers placed his works third behind those of respected artists Frederic Remington and Charles Russell. Boots is perhaps the best-known living Western artist.
Boots would like to sell a portion of his collection, but does not want to recognize a large amount of ordinary income this year.
Question:
Is there a solution for Boots?
Solution:
Boots could consider an inventory unitrust. Since the paintings are inventory for Boots and his basis is only the cost of the canvas and paint, the sale of art produces ordinary income. If the art were transferred to a charitable remainder unitrust, there would be no deduction on the initial transfer under the "intervening interest" rule of Sec. 170(a)(3). Even if he were to sell the art through the unitrust, the deduction would be very minimal, since it would be the remainder factor times the cost of paints and canvas.
But there is a very major benefit to Boots with the "artful unitrust." When the paintings are transferred to the unitrust and sold through the trust, Boots avoids paying ordinary income tax at his federal and state 40% rate. So there are very large potential savings.
Boots and his wife chose to transfer five paintings and receive a 5% income for their lifetimes. Since it may take some time for the paintings to sell, Boots and his attorney decided to create a FLIP unitrust. The unitrust trigger event is the sale of any two of the five paintings.
Boots transferred five exquisite paintings of Indian chiefs to the charitable remainder trust. The trust will FLIP to a standard unitrust on January 1 after any two of the five paintings have sold. The appraised value of the five paintings is $400,000.
Boots and his wife are very pleased. They saved over $100,000 in income tax by selling the paintings through the unitrust. While there is no significant charitable deduction, Boots and his wife will have a substantial income for life. Boots was last seen smiling as he rode Paintbrush into the Western sunset.
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