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Sunday, May 5, 2024
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Case Studies |
Unitrust Debt Solution
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Case:
Several years ago Mother and Father built a very unique home on 45 acres of beautiful rolling hills and woods. Father passed away three years ago, and Mother now solely owns the 45-acre parcel and home.
She enjoys the peaceful country view out her front window. However, the university adjacent to the property is very interested in acquiring the property for eventual future growth. Not surprisingly, Mother is concerned. She does not want a new dormitory filled with college students in her front yard. In fact, she enjoys the peace and protection of her lovely home in the wooded countryside. However, at age 80, she recognizes that eventually some planning will have to be accomplished.
After a thorough understanding of Mother's needs and desires, a wonderful four part solution was suggested which incorporated an outright sale, a unitrust, a gift annuity and a gift of a remainder interest in a home. This solution seemed like the perfect fit until Mother's attorney, Paul Weiss, discovered that Mother has a $20,000 loan against the rear 20-acre parcel. The rear 20-acre parcel of land was to be transferred into a charitable remainder unitrust.
Paul learned that apparently, prior to Father's death, Mother and Father took out a small loan at the local bank in order to do some simple improvements upon the land. The $20,000 debt was very modest in comparison to the $1 million fair market value, so Mother did not think it was an important issue. Paul believes otherwise.
Question:
Is the $20,000 debt on the rear 20-acre parcel a problem? If so, what solutions can Paul suggest? What are the rules governing encumbered property and unitrusts?
Solution:
In PLR 9015049, the Service set forth specific requirements dealing with the contribution of encumbered property into a unitrust. The Service stated that if there is any personal liability on the debt, then the payment of debt with potential personal liability causes the unitrust to become a grantor trust. See Sec. 677. Since the Sec. 664 regulations preclude a unitrust from being a grantor trust, the unitrust would, therefore, become disqualified (i.e., lose its tax-exempt status) under the Service's rationale. Accordingly, Paul's concerns are warranted.
Mother is personally liable for the $20,000 debt. Thus, the transfer of the encumbered rear 20-acre parcel into the unitrust would disqualify the trust under the rationale of PLR 9015049. Therefore, it is instrumental that Mother remove the $20,000 debt prior to transferring the property into the unitrust.
In this instance, the removal of the small debt is quite simple. Because the university is purchasing Mother's front 20-acre parcel for $1 million cash, Mother will have ample cash from the sale proceeds to pay off the $20,000 debt. After Mother pays off the debt, she can then safely contribute the rear 20-acre parcel into the unitrust, since it is now "free and clear." At this point, Mother can realize all of the unitrust benefits.
As a result of Paul's guidance, Mother proceeds safely ahead with her four-part solution. With her newfound liquidity, steady lifetime income and beautiful hillside views, Mother finds peace in the countryside (and her annual income stream) very agreeable.
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