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Sunday, April 28, 2024
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Case Studies |
A High Flyin' Unitrust
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Case:
Walter Hampton, age 65, is a flight instructor and runs a flying school. He is interested in retiring and would like to sell his business (structured as a sole proprietorship) and the plane he has been using for flight instruction. The business and plane have a fair market value of $250,000 and a depreciated cost basis of $50,000. His CPA has informed him that if he sells the plane, he would be required to report the difference between the sales price and his cost basis as ordinary income. In other words, the depreciation he has recognized on the plane would be recaptured for tax purposes as ordinary income. Therefore, ordinary income recognition of $200,000 would result from the sale of the plane.
Walter had recently attended an estate planning seminar sponsored by various local charities. In the seminar, one of the estate planning vehicles discussed was the charitable remainder unitrust. Among the benefits associated with the unitrust was the ability to bypass capital gains taxes. The examples used throughout the seminar primarily involved the use of such appreciated assets as stocks and real estate to fund the trust. Walter wonders whether an asset such as a plane can be used as the funding asset for a charitable trust. Since he likes the other benefits of the trust, such as lifetime income and the opportunity to make a substantial gift to his favorite charity, he would like to use the plane to fund the charitable trust.
Question:
Can the plane be utilized to fund a charitable remainder unitrust? If so, what are the resultant income and capital gains tax consequences?
Solution:
In meeting with the very knowledgeable Planned Gifts Director of his favorite charity, Walter learns that the plane is classified for tax purposes as tangible personal property. This is property that is movable - property other than land or improvements to land, such as buildings and other permanent structures. Tangible personal property includes works of art, autos, boats, antiques, china, stamp collections, rare coins, books, jewelry and the like.
The Planned Gifts Director stated that charitable remainder trusts can, in fact, be funded with tangible personal property. By doing so, however, the donor's deduction will be postponed if the income interest is payable to the donor or a close relative. When tangible personal property is contributed to a charitable trust and the donor or close relative has an "intervening interest" in the property, the income tax deduction is postponed until the intervening interest has expired or is held solely by unrelated persons. What this means is that no tax deduction is available to the donor until the property is sold within the trust and reinvested. See IRC Sec. 170(a)(3). This is known as the future interest rule that acts to postpone the otherwise available income tax deduction.
Because a plane is tangible personal property, the charitable income tax deduction for the remainder interest is not allowable as long as Walter retains an income interest in the plane. However, an income tax deduction would be allowed when the trustee of the charitable trust sells the plane. At that time, Walter would no longer retain an "intervening interest" in the tangible personal property and thus would be holding only an income interest in the plane's sale proceeds.
Furthermore, contributions of personal property are subject to the "unrelated interest" rules. If the plane is given to charity, unless the property is related to the exempt purpose of the donee charity, the income tax deduction is for basis only. A contribution of property to a charitable trust would be deemed an unrelated use and therefore, the income tax deduction is for cost basis only. Therefore, instead of basing the income tax deduction on the appraised value of $250,000, the deduction would be calculated on Walter's basis of $50,000.
Finally, Walter is pleased to learn that any gain (or ordinary income in the case of selling the plane) would not be attributable to Walter, but would be attributable to the trust. Therefore, the ordinary income on the sale of the plane would be subject to the bypass of gain benefit rule.
As a result of this very fine explanation by the Planned Gifts Director, Walter decides to fund a 7% charitable remainder unitrust with the plane. Therefore, he will receive an income tax deduction of approximately $19,000 when the plane is sold by the trustee (based on his cost basis of $50,000). Assuming the plane sells for $250,000, he will begin receiving income distributions of $17,500 per year from the trust. When Walter passes away, the trust assets will be distributed to his favorite charity, thus fulfilling his desire to make a substantial charitable gift.
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