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Thursday, May 2, 2024
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Case Studies |
Unitrust Debt - Are There Other Solutions?
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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 from 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 on 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 Section 677. Since the Section 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 some cases Mother could simple pay off the debt. But Mother wants to explore all of the options. What other possible ways exist to solve the debt problem?
First, if Mother does not want to pay off the debt, she could transfer the debt to her home and have the release on the 20 acres recorded. Second, she could sell a part of the 20 acres to the charity and, after the loan is repaid, transfer the balance of the 20 acres into the unitrust. Third, while this strategy has not been approved by the Service, some donors have transferred 98% of the 20 acres into the unitrust and given a personal guarantee that they will pay the debt from their portion or other assets. After the sale, the debt is paid and the trust funded with the $980,000. While this strategy involves some risk, after the trust has received cash, it is unlikely that the Service will question the transaction.
After thinking through these choices, Mother finally decided that paying the $20,000 with cash was still the best option. Today, Mother finds peace in the countryside (and her annual income stream) very agreeable.
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