Friday April 26, 2024

4.1.4 Art to Charitable Remainder Trusts

Art to Charitable Remainder Trusts

Transfer of Art:  Art may be transferred to a charitable remainder unitrust or annuity trust.

Charitable Tax Deduction:  When tangible personal property is transferred to a charitable remainder trust, there are two specific rules that limit the deduction.

Calculation of Charitable Deduction:  In order to calculate the charitable deduction, both of the above rules plus the rules for selecting the Applicable Federal Rate must be applied.

Gifts to Trust by the Artist:  When an artist has created a painting, the artwork represents potential ordinary income.

Retained Interests:  When art is transferred to a charitable trust, the trustee must be able to sell the property.

Transfer of Art
Art may be transferred to a charitable remainder unitrust or annuity trust. Since it may be difficult to sell the art, it is nearly always preferable to transfer the art to a charitable remainder unitrust. Generally, the unitrust will use either a net income plus makeup or a FLIP formula payout. If a FLIP unitrust is selected, the trigger event for the FLIP would be the sale of the art. The FLIP trust will be a net income trust until the art is sold. On the following January 1, the FLIP trust may then become a straight unitrust.

Charitable Tax Deduction
When tangible personal property is transferred to a charitable remainder trust, there are two specific rules that limit the deduction. First, there is no charitable deduction for a future interest in tangible personal property. The deduction applies only after all "intervening interests" have expired. Sec. 170(a)(3) .

Therefore, when art is transferred to a charitable remainder unitrust, there is no charitable deduction at that time. However, if the art is then sold by the trust, the charitable deduction is available in the year of the sale. After the art has been sold and cash received by the trust, the intervening interest in the tangible personal property has expired. Reg. 1.170A-5(a)(1).

The second rule also operates to reduce the charitable deduction from fair market value to cost basis, assuming that FMV exceeds cost basis. Even after the art is sold and the intervening interest has terminated, there still has been a transfer of tangible personal property for unrelated use. Therefore, the charitable deduction is the cost basis of the property times the remainder factor. Reg. 1.170A-5(b)(7).

Calculation of Charitable Deduction
In order to calculate the charitable deduction, both of the above rules plus the rules for selecting the Applicable Federal Rate (AFR) must be applied. This calculation will be different from that of a unitrust funded with cash or public stock, since the valuation date is deferred under the "intervening interest" rule.

Each transfer to a charitable trust must be valued on a "valuation date." Sec. 7520(d). For a gift of tangible personal property to a unitrust, the value is first reduced from fair market value to cost basis under the unrelated use rule. However, there still must be a valuation, since a charitable deduction is permitted at cost basis only if the fair market value is equal to or greater than cost basis.

Therefore, when the asset is sold, the intervening interest has terminated and the charitable deduction will be the appropriate factor times the lesser of cost basis or fair market value. The required AFR will be the rate for the month of that valuation date or either of the prior two months. Sec. 7520(a)(2).

Example 4.1.4A Gift of Porcelain

Mary Smith loves Chinese porcelain and has collected over 50 exquisite pieces of porcelain in her lifetime. The collection is valued at approximately $300,000.

Since it is a very large and valuable collection, after it is transferred to the unitrust, the trustee confers with an agent who is experienced in sales of these items. The agent proposes to have a public auction of the Chinese porcelain at three different times and in three different locations. A plan is established to sell at auction a third of the collection in New York in December, a third of the collection in London in January and a third of the collection in Paris in May of that year.

Since the funding date will then be December for the first sale, the calculation is made using the AFR from December or one of the prior two months. Similarly, the funding dates and charitable deductions for the January and May in the following year will be done separately using the AFR for the sale month or one of the prior two months. Each deduction calculation will use the cost basis of that part of the collection and the AFR for the month of funding (or the prior two months).

Gifts to Trust by the Artist
When an artist has created a painting, the artwork represents potential ordinary income. If the artist were to sell that painting, since creating art is the profession of the artist, the difference between the cost basis of the painting and the amount received would be ordinary income. Since the cost basis is the value of the canvas and paints, artists typically have near-zero cost basis in a painting.

However, while there is little or no potential charitable income tax deduction, it still may be very desirable for the artist to transfer the art to a charitable remainder trust. Sec. 170(e)(3). When the artist transfers the painting to a charitable remainder unitrust, the painting may be sold by the trust and the tax on the ordinary income is avoided. Since this trust has been funded with an ordinary income asset, it will pay out ordinary income for the duration of the trust.

Example 4.1.4B Gift by the Artist

Mary Artist has created an exquisite landscape. Her painting titled "Mountain Wildflowers" has a net sale value of $300,000. Her costs for the canvas and paints are nominal and she has in essence a zero basis in the painting.

Mary transfers the painting into a two-life charitable remainder unitrust for herself and her husband John. While there is no income tax deduction for the ordinary income asset, she avoids payment of 40% federal and state ordinary income tax on the artwork and saves $120,000 that otherwise would have been paid in tax. She and John then receive the 6% income for two lives. At the end of the two lives, the trust principal will be distributed to a favorite art museum.

For an artist, this plan is excellent. Avoiding the ordinary income tax can in some cases generate greater total savings than the combined capital gain bypass and charitable tax savings with a capital asset transferred to trust.

Example 4.1.4C

Blake and Amy Art Collectors are purchasers of western art. They discover an extraordinary Charles Russell oil painting of western Montana and purchase it for $100,000. Many years later, the painting is worth $400,000. Blake and Amy are pleased with the painting, but also desire increased income during their retirement years.

They transfer the painting into a FLIP unitrust. Based on an appraisal by a qualified independent appraiser, the $400,000 value is first reduced to the $100,000 basis. Applying the applicable remainder interest factor, the charitable tax deduction equals $36,149. This deduction applies in the year that the painting is sold.

After 15% sale costs, the trust holds $340,000 in cash. Blake and Amy receive 6% of this amount for their lifetimes. If the trust principal increases in value, the income will also increase proportionately. Over their estimated 20.6-year life expectancy, Blake and Amy could receive a total of $541,168.

Retained Interests
When art is transferred to a charitable trust, the trustee must be able to sell the property. The donor or donor's family may not retain the use of the property or restrict the sale. Retaining the use of the property or restricting the sale would cause the trust to fail to be qualified. Rev. Rul. 73-610.

Case Studies on Art to Charitable Remainder Trusts

Getting Back to the "Art of the Matter," Part 5:   Paulo Frambini, 45, is a talented artist and a self-proclaimed leader of the art purist movement. He lives, breathes and eats art history and culture. Paulo refuses to be characterized as any one particular type of artist. Accordingly, Paulo's artistic creations are very diverse and varied.

Getting Back to the "Art of the Matter," Part 6:   Paulo Frambini, 45, is a talented artist and a self-proclaimed leader of the art purist movement. He lives, breathes and eats art history and culture. Paulo refuses to be characterized as any one particular type of artist. Accordingly, Paulo's artistic creations are very diverse and varied.

The Artful Unitrust:   Billy "Boots" Belton has loved the west his entire life. He was born in California, but moved to the wide-open spaces of western New Mexico. During his youth, Boots studied art at a large art institute in California, but the call of the big sky led him back to his beloved western New Mexico.

Related Topics on Art to Charitable Remainder Trusts

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.

4.1.1  Gifts of Art:    There are many different types of works of art. Individuals may own paintings, sculpture, porcelain, artistic screens, scrimshaw, carvings and other types of art. Generally, rare books, letters and other written materials may also be considered art.

      Quiz-Basic



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