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Sunday, May 5, 2024
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Case Studies |
First National Bank of the CRT
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Case:
Eugene and Caroline Butler, both age 84, funded a charitable remainder unitrust back in the mid 1980's with $250,000 of highly appreciated real estate. Because of the illiquid nature of the property, a net income with makeup unitrust (NIMCRUT) was selected. They chose an 8% trust distribution percentage which was a reasonable payout rate based upon interest rates at that time. Therefore, the trust was written so that they would receive the lesser of net income or 8% of the fair market value of the trust as valued annually. No provision was drafted into the unitrust document to allow for distributions of capital gains as income since this creative concept was not yet being discussed in planned giving circles.
The property sold within the first year of the trust's existence and Eugene and Caroline enjoyed trust distributions of 8% the first few years of the trust. With interest rates hovering around 8% in the mid 80's, the trustee was able to invest in very safe bond and income funds to produce the 8% payout. However, interest rates have steadily declined over the past several years and Eugene and Caroline have been receiving payouts of only 4%-5%. This has caused some consternation for them, the charity's foundation and the charity which had recommended the trust to them in the first place. They considered a FLIP, but did not like the prospect of investing in stocks.
The charity, which is the sole irrevocable charitable remainderman of the unitrust, and the trustee have explored a number of avenues to increase the trust income. Since trustees are under the "prudent investor rule" and have a fiduciary responsibility to all trust beneficiaries, the investment strategy that is being utilized at this time is within those guidelines. Currently, the investment mix is 70% bonds, 20% stock and 10% cash and, therefore, leans toward the production of income. This is a good conservative investment mix with which the trustee is comfortable.
The charity recently concluded a building campaign to construct a new performing arts auditorium. Upon the conclusion of the campaign, the charity came to the conclusion that they would have to borrow $350,000 to finish the auditorium. They have approached various banks which will assess interest rates of about 8%. In addition, they would have to pay lender's fees such as title insurance, origination fees, discount points, etc. After exploring the various possibilities, the charity's board feels that bank financing is probably the best course of action.
Question:
Under these circumstances, is there a prudent method whereby the trustee can invest to increase the trust income distributed to Eugene and Caroline?
Solution:
According to Private Letter Ruling 8807082, the charitable remainderman can borrow funds from a charitable trust. Since the charity is planning on borrowing the $350,000 from a bank, a more favorable course of action would be simply to borrow the funds from the unitrust. Since the distribution percentage on the trust is 8%, the decision is made to loan the funds to the charity at this rate. The charity will borrow the funds from the unitrust, secure the loan with the auditorium property and pay interest only at 8% throughout the lifetimes of Eugene and Caroline.
The results of this arrangement are favorable for both the charity and for Eugene and Caroline. The charity will be able to borrow the funds necessary without all the requisite lender's fees. They will never have to repay the principal of the loan as the charity is the ultimate remainderman of the trust and as remainderman will receive all the trust assets upon the termination of the trust (passing of Eugene and Caroline). The only asset that the trust will hold at that time, assuming the loan stays outstanding throughout the beneficiaries' life expectancies, is a note receivable from the charity. In other words, the charity will owe itself; in essence, a self-forgiving note. Eugene and Caroline are very pleased since they will now be receiving 8% on the current fair market value of the trust or $28,000 per year, thereby increasing their income substantially.
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