Friday April 19, 2024

3.11.3 Sale and Unitrust

Sale and Unitrust

The "Great Home Buy-Down":   Many couples or single persons of retirement age are living in large single-family dwellings.

A Retirement Couple:   Over the years, John and Mary Jones have enjoyed a good life.

The Plan:   There is indeed a plan that would enable them to have cash in the bank, acquire the new condominium, receive a very significant increase in income and accomplish all of this with no taxation.

The Steps:   First, John and Mary move out of the home.

Zero Taxes:   How are John and Mary able to do this with Zero Taxes?

The Pitfalls:   There are two particular cautions that must be emphasized with respect to the "Great Home Buy-Down."

The "Great Home Buy-Down"

Many couples or single persons of retirement age are living in large single-family dwellings. Like many Americans, they purchased a large home in their mid forties, when there were still children at home. Now, the children are out of the nest, the home is paid for and our friends have more home and more responsibility than they desire. But given the appreciation in their home, many owners with valuable homes are unwilling to sell and pay a large tax.

Is there a solution? Can they find true happiness, a smaller home that fits their needs and zero taxation? The "Great Home Buy-Down" could be just the answer to fulfill their goals and desires.

A Retirement Couple

Over the years, John and Mary Jones have enjoyed a good life. They bought an initial starter home, but as their children grew older they sold that residence, rolled over the gain and acquired a second home. Their current residence is the third home they've purchased. It is now worth approximately $1,800,000 with a cost basis of $200,000. Actually, John and Mary no longer need the big home and would be quite happy with a smaller retirement condominium. However, they do not want to sell the big home and pay a large capital gains tax. Is there a solution for our friends John and Mary?

The Plan

There is indeed a plan that would enable them to have cash in the bank, acquire the new condominium, receive a very significant increase in income and accomplish all of this with no taxation. The plan involves transferring half the value of the home into a charitable remainder unitrust and then a joint sale by the trustee of the trust and John and Mary.

The Steps

First, John and Mary move out of the home. Second, they deed one half of the home to a charitable remainder unitrust. Third, they and the unitrust list the home for sale and sell the property. Fourth, at closing, the proceeds are divided between the unitrust and John and Mary Jones.

Zero Taxes

How are John and Mary able to do this with zero taxes? First, the one half of the property that is transferred to a remainder trust will bypass capital gain under Sec. 664, so long as there is no pre-arranged sale. The basics of avoiding pre-arranged sale are that the trustee must have lawful capability to select the purchaser and the price. One half of the basis is allocated to one half of the value in the trust, leaving the other half of the value, approximately $900,000, and the remaining $100,000 of basis.

When the property is sold, it is possible to protect $500,000 of the sale price with the exclusion and, with the $100,000 of allocated basis, the gain is now $300,000. The $500,000 exclusion is available if John or Mary Jones have lived in their principal residence for two of the last five years.

Fortunately, there is a charitable income tax deduction of approximately $300,000 that offsets the long term capital gain. This gain will be recognized in the current year and the deduction will be subject to the 30% of adjusted gross income limit. In some cases, the result is a payment of a modest amount of tax in year one and tax refunds in future years due to charitable deduction carry forwards. However, the net result is still zero taxes when viewed from a multi-year perspective.

The Pitfalls

There are two particular cautions that must be emphasized with respect to the "Great Home Buy-Down." First, the self-dealing rules of Sec. 4941 are designed to prevent one from receiving benefits from the trust other than the stated trust income amount. This self-dealing rule states that one cannot "buy, sell, lease or otherwise transact business with the trust," meaning that one cannot live in their unitrust. Does that mean that the Jones cannot live there even if they pay rent? Yes, that would violate the self-dealing rules. And, since John and Mary are giving half of a four-bedroom house to the trust, may they live in two bedrooms and permit the trustee to use the other two? No, that still is not acceptable -- the owners must move out prior to deeding the partial interest to the trust.

This rule is especially important after PLR 9114025. In this Private Letter Ruling, an attorney initially approached the IRS and asked for a favorable Private Letter Ruling on the transfer of a partial interest in real property to a unitrust. The IRS initially refused to give a favorable ruling and later gave a favorable ruling only after the property was transferred to a limited partnership.

In this ruling, the Service viewed the joint ownership between the donors (considered prohibited parties from a self-dealing standpoint by the IRS) and the trustee as potentially facilitating manipulation of value. Possibly, donors could receive greater than proportionate value and the trust receive less than its fair share of value. Two very important issues are raised in this ruling. First, the favorable ruling emphasized that there was no use by the donors of the jointly held property. Second, there was an independent trustee.

Thus, it appears that it is possible to complete the home buy-down if one is very careful to avoid any use of the property by the donor and there is an independent trustee for the remainder trust. Indeed, it is very desirable to create both a revocable trust and a unitrust with the same independent trustee managing both. The donors transfer half of the home into the unitrust and the other half into the revocable trust. The trustee handles the sale and then allocates pro rata proceeds into the two trusts. At that time, donors can recover the $900,000 in proceeds from the revocable trust.

The Great Home Buy-Down is a wonderful plan. John and Mary Jones received no income before from their primary residence and were forced to expend considerable sums to pay taxes and maintenance on their large home. They are much happier now in their new retirement condominium and have significant income from the remainder trust plus the $900,000 cash in the bank. Their life has improved dramatically. Best of all, this improvement was accomplished with no net payment of taxes.

Example 3.11.3C Sale of Home and Unitrust

Carl and Sue Johnson have lived in their home for many years. It has a cost basis of $100,000 and is valued at approximately $1,000,000. They are interested in obtaining cash to move to a retirement condo. They no longer need the large four-bedroom home, and the cost and effort to maintain the property are incompatible with the freedom that they would hope to enjoy during their retirement years.

Carl and Sue qualify for the $500,000 exclusion of capital gain. They could not sell the million-dollar property, however, without payment of some capital gains tax. It would be better in their view if there was a "capital gains tax-free" sale option.

Carl and Sue estimate that it will cost approximately 7% or $70,000 to sell their home. They transfer 40% or $400,000 into a 6% charitable remainder trust. The trustee and the Johnsons then jointly sell the property and divide the $70,000 of costs pro rata between the unitrust and the Johnsons. The unitrust nets $372,000 and the Johnsons receive $558,000.

Since they can use their $500,000 exclusion to offset the gain on the sale portion, there is no tax on the sale portion. They bypass $332,000 of gain on the unitrust and save $49,800. In addition, they receive an income tax deduction of $49,000 with the charitable remainder unitrust. This saves additional taxes on their other income.

For their two lives plus a term of twenty years, the unitrust will make payments of 6%. Assuming that it earns 8% and pays 6%, there will be 2% growth. This is quite important, since the trust could last 30 or even 40 years. In the anticipated 43.1 years, the trust will pay over $1.5 million to the Johnsons and to their children.

The Johnsons are able to use part of the cash to purchase their retirement condominium. They use the balance of the cash for liquidity and investment purposes. In addition, they have the unitrust income for their lives. This "Great Home Buy-Down" using the unitrust and the home-sale exclusion is an excellent plan that greatly enhances their retirement security.

Case Studies on Sale and Unitrust

A Tax-Effective Way to Sell a Closely Held Business:   Daniel and Lorraine White, both age 60, started a comprehensive financial planning business over 30 years ago. With hard work and a lifelong commitment to building the business, they now have over 30 employees who serve many of the high net worth clientele in their city. Over the years, Daniel and Lorraine have branched out into a number of financial areas, one of which is online investing. This aspect of the business has done extremely well and the company has grown substantially over the past three years. The net worth of the company is now projected to be over $5.5 million.

Deferred Gift Benefits Children's Hospital Now:   Ever since Theresa and Bob Anderson lost their child many years ago to disease, they have been true champions for children's disease research and care. They immediately started volunteering with the local children's hospital and eventually joined the hospital's foundation board. As active and compassionate board members, Theresa and Bob were commonly found fundraising at local events as well as consoling grieving parents at hospital bedsides.

Tax-Free $2 Million Home Sale:   Jack and Donna Bell, both 70, are retired geologists who lived and worked in Virginia their entire lives. They raised four children, all girls, in a beautiful, six-bedroom, 5,000 square foot home. However, the children moved out many years ago, and it is now just the two of them in the six-bedroom home. The upkeep and maintenance of such a large home has been very difficult for Jack and Donna to sustain. In addition, the cold Virginia winters have become increasingly harsher on Donna who suffers from a severe case of arthritis. As a result, Jack and Donna have reluctantly decided that it is time to finally sell the family home. They will then move to Florida where they could enjoy warmer weather and purchase a smaller, more manageable home.

A Runner's C Corporation, Part 1:   Rob Hansen, 65, runs The Shoe Factory, Inc., which is located in Boise, Idaho. The Shoe Factory is actually a building where national shoe companies come to manufacture their product. It is an enormous 50,000 square foot, high tech facility designed specifically to accommodate shoe production. Accordingly, Rob's company leases the space to clients interested in such a facility. Rob has operated the business successfully for over 35 years and has put in many long hard hours during that time. Therefore, at the age of 65, he is ready to retire and enjoy the fruits of his labor.

A Runner's C Corporation, Part 2:   In part one, Rob Hansen, 65, decided to retire and sell his company, The Shoe Factory, Inc. Specifically, the Shoe Factory was going to fund a Charitable Remainder Unitrust (CRUT) with 60% of its main asset - a building and land valued at $10,000,000. Afterwards, the Shoe Factory, which still owns a 40% interest, and the CRUT would sell the property to a new buyer. At that point, the CRUT would receive $6,000,000 (60% x $10,000,000) minus any selling costs. The company would accordingly receive $4,000,000 minus its share of selling costs. Because the 40% portion was sold outside of the CRT, it is a fully taxable transaction to The Shoe Factory. To help offset some of the resulting tax burden, The Shoe Factory is entitled to a corporate income tax charitable deduction of $1,480,000 for creating the CRUT, which is subject to the 10% of taxable income limitation. Any excess charitable deduction will be carried forward for five years.

If You Sell It, The Benefits Will Come and Come and Come...:   Samuel and Sarah Wright, ages 72 and 70 respectively, live in a small farming community 30 miles west of Phoenix. For the past 40 years, they have farmed 130 acres of land. The land was inherited from Sarah's parents and, therefore, their cost basis in the property is about $100 per acre. Samuel and Sarah have five children, ages 40-50. Two of the children are teachers, one is a Minister of Music at a local church, one is a missionary and other is a farmer in the Tucson area. Each of them is married and they have ten children among them. Their children are good parents and hard workers, are civic minded and "make Mom and Dad proud."

Exit Strategies for Real Estate Investors, Part 6:   Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. Karl's passion was real estate, and he was very successful in his investments.

Exit Strategies for Real Estate Investors, Part 7:   Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. Karl's passion was real estate, and he was very successful in his investments.

Exit Strategies for Real Estate Investors, Part 17 The Double Deferral Solution:   Karl Hendricks was a man with the golden touch. Throughout his life, it seemed every investment idea that he touched turned to gold. Karl's passion was real estate, and he was very successful in his investments.

Grizzly Gordon and the Ranch LLC, Part IV:   Grizzly Gordon grew up in the Big Sky country. He loved the mountain and plain vistas of this beautiful ranching country. During his youth, Grizzly acquired his nickname by discovering a grizzly bear that had gotten too near his cattle. Grizzly felled the bear with one well-aimed shot and all his neighbors called him Grizzly after that experience.

Southern Brat Unitrust and Sale Bailout:   Peter and Sue Olson were raised in the great North Country. After college, they were married, and Peter accepted a position with one of the nation's largest discount stores.

Sale of a Closely Held Business with Zero Taxes:   Robert and Betty Johnson, ages 70 and 65, respectively, have an estate valued at $3.5 million. Included in the estate is a small business valued at $1 million. The business, which is structured as a "C" corporation, was started on a "shoestring" twenty years ago and, therefore, Robert and Betty have relatively no basis in their stock. They would like to sell the business to three faithful employees who have been working in the business the past ten years. The employees have verbally expressed an interest in buying the business, but no documentation has been signed. In talking with their CPA about the sale, they are very concerned about the capital gains taxes that would be due if the stock is sold. Also, they have been quite active in charitable work throughout their marriage and thought perhaps they would like to use a portion of the business to eventually make a charitable gift to their alma mater and to their church.

A CRT Solution for Real Estate "In the Zone":   Wayne and Betty Ramsey own a 40-acre piece of property located on the outskirts of town which is zoned as agricultural property. Eight years ago, the county passed a controlled growth ordinance in which agricultural land could only be developed in accordance with a well-defined schedule as set forth in the ordinance. This ordinance was passed by a very slim margin in that year's election and was designed to prevent the urban sprawl which has occurred in other local communities. The primary aim of the ordinance was to protect the open spaces in the county which have been steadily disappearing over the past ten to fifteen years due to local development. The terms and conditions of the ordinance run for a period of ten years and, therefore, two years still remain before the Ramseys can sell their farmland to a real estate developer at a top dollar price.

Private Letter Rulings

PLR 9015049 Debt Not Permitted on Assets for Unitrust:   In PLR 9015049, the Service set forth a specific requirement concerning any asset encumbered by debt. Previously, it was thought permissible to transfer an asset into a charitable remainder trust so long as the debt was at least five years old and the owner had held title for at least five years. However, in PLR 9015049, the Service took the position that if there is any personal liability on the debt, under Sec. 677(a), the payment of debt with potential personal liability causes the unitrust to become a grantor trust. Since the regulations in Sec. 664 preclude a unitrust from being a grantor trust, the trust is disqualified under the rationale of the Service.

PLR 9114025 Split Gifts and Self-Dealing:   In PLR 9114025, the Service permitted undivided interests in real estate to be transferred into limited partnerships and subsequently transferred to charitable remainder unitrusts (CRUTs).

Related Topics on Sale and Unitrust

3.10.1  Unitrust Duration and Recipients:    A charitable remainder unitrust (CRT) pays a fixed percentage for a life, lives, a term of up to 20 years, or a combination of a life or lives and a term up to 20 years. Reg. 1.664-3(a)(5)(i). In most circumstances, the income is paid to the donor for one life or to donor and spouse for two lives. Alternatively, the unitrust amounts may be paid for a term of no more than 20 years, or for a combination.

3.10.9  Income, Gift, Estate and Generation-Skipping Transfer Taxes:    The donor to a charitable remainder unitrust will receive an income tax deduction equal to the present value of the remainder interest. It is calculated using the applicable federal rate for the current month or one of the prior two months, as permitted under Sec. 7520.

      Quiz-Basic



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