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Monday, April 29, 2024
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Case Studies |
Turning a Farm into a "Field of Dreams"
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Case:
Duane and Ruth Bradley, both age 65, have farmed their homestead for the past 35 years. Ruth inherited this land consisting of 85 acres from her grandfather in the late 1950s. At the time of the inheritance, the acreage was valued at only $100 per acre and therefore, the basis in the property is only $8,500. Over the last ten years, the local community has experienced substantial development and now the property is located right on the outskirts of town. The property in the area is now selling for $12,500 per acre and therefore, the fair market value of their land is currently over $1 million. Duane and Ruth have been planning to use the property for their retirement as they have been unable to put any substantial sums aside over the years for this purpose. They have sacrificed greatly to put each of their five children through college and now must think about their retirement. Fortunately, the land has appreciated greatly over the last few years and they can now look to the property to provide a comfortable retirement.
Duane and Ruth have both been involved with a number a charities over the years and are particularly fond of the local chapter of the Future Farmers of America. They have decided that they would like most of their estate to pass to the FFA to promote farming and agriculture among the local youth. They feel very deeply that in providing their children with a good home and a quality education, they have given their children everything they need to succeed in life. Therefore, their estate plan is structured so that each child will receive $10,000 each at their demise with the balance of the estate to charity.
Duane and Ruth would like to continue to live in their home, retain five acres surrounding the home and then sell the remaining 80 acres. They are concerned that substantial capital gains taxes in the range of $250,000 would be assessed on the sale of the property. They would like to avoid these onerous taxes, if possible, and eventually would like to see the $1,000,000 pass to the FFA.
Question:
What would be the best method for Duane and Ruth to receive retirement income, bypass the capital gains taxes and see the value of the property pass to the FFA upon their demise?
Solution:
In meeting with the Director of Gift and Estate Planning at the FFA, Duane and Ruth were introduced to the concept of the FLIP - a charitable remainder trust which would pay them income for the rest of their lives. The trust would begin as a net income with makeup trust and then convert to a standard or straight pay trust on January 1st following the sale date of the property. Duane and Ruth decide to choose a 7% payout trust and are informed that they would receive the following benefits:
1) As a result of transferring the property to the trust which would, in turn, sell the property, all capital gains taxes would be bypassed. Therefore, $1 million would be available to reinvest and pay income to Duane and Ruth for their lifetimes.
2) The transfer of the property to the trust would generate an income tax deduction of $242,430. As a result of the 30% adjusted gross income deduction limitation and projected income of $75,000 per year, they would only be allowed to deduct about $135,000 over the allowable 6-year period.
3) Duane and Ruth have been working sun-up-to-sun-down over the past 35 years and have experienced the many hazards of farming, one of which is very limited income. In fact, the most income that they have been able to produce from the farm in the past was $50,000 annually...and that was a good year! Now, with the trust, they will receive $70,000 per year without having to toil year by year. Assuming an 8% trust return, the income distributions from the trust will increase year by year which will help to keep pace with inflation. Overall, projected lifetime income from the trust will approach $2 million!
4) They will provide a substantial gift to the FFA upon their passing which will be used by the charity to promote agriculture among youth as they desired.
Duane and Ruth are very pleased with the results of utilizing the charitable trust to sell their property. The farm property has literally been converted into a field of fulfilled dreams - provision currently for retirement, capital gains bypass and future provision for their favorite charity.
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