Friday March 29, 2024

4.3.3 Tangible Personal Property Unitrust

Tangible Personal Property Unitrust

Tangible Personal Property Assets:  There are a number of assets that have ordinary income potential and are tangible personal property.

The Rawhide Unitrust:  Cattle and crops are types of tangible personal property that may be used to fund a charitable remainder unitrust.

Bypassing Ordinary Income:  The principal benefit of a tangible personal property unitrust is to defer recognition of ordinary income.

Tangible Personal Property Assets


There are a number of assets that have ordinary income potential and are tangible personal property. Works of art created by an artist, farm products raised by a farmer and most cattle owned by a rancher would generate ordinary income upon sale. In addition, equipment, vehicles, aircraft and other items that are subject to depreciation could generate gain recaptured as ordinary income upon sale. All of these assets may be appropriate candidates for a tangible personal property unitrust.

The Rawhide Unitrust


Cattle and crops are types of tangible personal property that may be used to fund a charitable remainder unitrust. Cattle or crops are generally inventory for the farmer or rancher, and thus would usually produce ordinary income when sold. In order to bypass this ordinary income, the farmer or rancher could transfer the cattle or crops into a charitable remainder unitrust.

When tangible personal property is transferred into a unitrust, four rules impact the charitable deduction. First, the transfer of assets into a unitrust creates an "intervening interest" under Sec. 170(a)(3). This section was created to preclude deductions for claimed "gifts" of art in which the donor retained possession of the donated art for a period of time. The charitable deduction is effective after the donor actually relinquishes possession of the art and transfers it to the charity.

With a charitable remainder trust, Sec. 170(a)(3) causes the deduction to be delayed until the asset is sold. At that time, there is no longer an "intervening interest," since the asset has been converted to cash. During an "intervening interest" period, the donor must follow the Sec. 4941 rules regarding self-dealing.

The second rule relates to unrelated use regulation. When tangible personal property is transferred to a charitable remainder unitrust, the asset is always deemed to be an unrelated use. Therefore, the deduction is limited to cost basis times the applicable unitrust factor. The unitrust deduction factor for a remainder interest will consider the payout and duration of the trust.

The third rule relates to partial interests. It is best to harvest or sever crops from the land prior to the transfer. For example, it is preferable to harvest the wheat, cut the hay or cut the timber prior to a transfer to charity or into a charitable trust. This avoids any potential partial interest problems since the entire harvested crop is transferred to the CRUT.

The last rule concerns issues of unrelated business income (UBI). If the donor is funding the trust with cattle or other livestock, the trustee should be aware of Internal Revenue Service Private Letter Ruling (PLR) 9413020. While PLRs are not binding precedent, they can be helpful to determine the Service's treatment of certain transactions. In the PLR, the donor requested rulings on various topics, including the determination that the donation of cattle and farm equipment to a CRUT would not generate UBI. The donor was able to bypass recognition of the ordinary gain so long as the trust was not engaged in an active business. Conducting an active trade or business would violate the UBI rules. In the PLR, it was specifically represented that efforts to "fatten the cattle for market" would not occur and the IRS deemed no UBI would be generated.

It is important to note that if the animals in the CRUT are raised for consumption, the trustee should carefully oversee that the feeding will be for maintenance purposes only. This may avoid the CRUT being deemed to be engaged in an active trade or business.

Trustees often use auction houses, agents or elevators to complete the sale of crops, cattle and other farming equipment. The trustee must be under no legally binding obligation to sell the assets being donated to the unitrust. In addition, to show evidence that the crops or cattle have been transferred, the bill of sale must show that the crops or cattle were sold by the trustee of the CRUT. It may be wise for a donor to have an independent trustee for the sale of the TPP assets.

Example 4.3.3A Rawhide Unitrust

John Rancher has a herd of 100 yearling steers. If sold, this inventory would produce ordinary income. John transfers the cattle into a charitable remainder unitrust with a deed of gift. To minimize any potential risk with respect to prearranged sale, his financial advisor serves as initial trustee. The financial advisor immediately has the cattle transported to market and sold. Under Sec. 170(a)(3), John's deduction is delayed until the cattle are sold. Because this is a gift of tangible personal property for an unrelated use, the deduction is limited to cost basis. The cattle had a fair market value of $100,000 and, because John deducted all of his expenses, a cost basis of $0. Therefore, the charitable deduction equals $0. However, John is very pleased to avoid paying tax on $100,000 of ordinary income. The full $100,000 in his rawhide unitrust will earn income for John and his wife Lois for many years.

Example 4.3.3B Tractor Unitrust

Frank Farmer bought a tractor for $300,000. He used it for several years on the farm and his CPA properly claimed depreciation each year. It is now valued at $100,000 with an adjusted basis of $30,000. Because recapture of equipment depreciation produces ordinary income, if Frank sold the tractor for $100,000 he would recognize ordinary income of $70,000. Instead, he transfers the tractor into a charitable remainder unitrust. To minimize any potential risk with respect to prearranged sale, his financial advisor serves as initial trustee. The financial advisor immediately offers the tractor for sale and another farmer purchases it from the CRT for $100,000. Under Sec. 170(a)(3), Frank's deduction is delayed until the tractor is sold. Because transfer of the tractor is a gift of tangible personal property for an unrelated use, the deduction is limited to cost basis. The tractor had fair market value of $100,000 and a cost basis of $30,000. Based on the estimated duration of the trust and payout percentage, the remainder factor is 0.20. Therefore, the charitable deduction is 20% of the $30,000 adjusted basis or $6,000. This deduction is calculated using cost basis and thus is a 50%-type charitable deduction.

Example 4.3.3C Crop Unitrust

Paul had an excellent crop this year. He sold most of his corn crop, recovered all expenses and has a current profit. In addition, Paul has 50,000 bushels of corn in his storage bin. Because he has recovered his costs, there is zero basis on the 50,000 bushels. Since the corn is inventory, if he were to sell, the federal and state income tax rate will be over 40%. Paul uses a Deed of Gift to transfer the corn into a charitable remainder unitrust. To minimize any potential risk with respect to prearranged sale, his financial advisor serves as initial trustee. The financial advisor immediately has the corn transported to market and then sold. The market administrator signed a statement that the corn was sold by the CRUT. Under Sec. 170(a)(3), Paul's deduction is delayed until the corn is sold. The corn is sold for $350,000. Since this is a gift of TPP to a CRUT, the deduction is limited to cost basis. Because the cost basis is zero, there is no charitable income tax deduction. However, Paul and Karen saved the ordinary income tax on the sale, and effectively "banked" the $350,000 value tax-free. Paul and Karen will now receive income for two lives from the trust. Because the value of their income for two lives may equal the after-tax value from an outright sale, the unitrust is an excellent solution for Paul and Karen.

Bypassing Ordinary Income


The principal benefit of a tangible personal property unitrust is the ability to defer recognition of ordinary income. If a farmer, rancher, manufacturer or other person holds an ordinary income asset, it may be desirable to create a unitrust to receive that asset. Even though there may be very modest or no charitable deduction, the avoidance of ordinary income tax on sale of the asset could be a very substantial saving.

Since the tangible personal property unitrust will have largely Tier 1 ordinary income when the asset is sold, it is customary to use a separate trust for the tangible personal property and a second unitrust for land, stock or other capital gain property. The tangible personal property unitrust will pay out fully taxable ordinary income.

However, the "capital-gain" trust funded with land or corporate stock may be invested under the four-tier structure. A portion of the earnings from this trust could be regular ordinary income. But the balance of the earnings could be qualified dividends or recognized long-term capital gain, both taxable at 15% for federal purposes. Thus, the tangible personal property unitrust should be separate from a unitrust that holds capital gain assets.

Case Studies on Tangible Personal Property Unitrust

The Gas Guzzler's Deduction, Part 4:   Brandon Bigtop loves his truck, which he affectionately named "the Beast." It was a gift for Brandon's eighteenth birthday. It is painted bright red and is two tons of metal, muscle and noise. Indeed, many neighbors would grumble as Brandon drove by because the rumbling engine could be heard three blocks away. As you can imagine, 18-year old Brandon was in truck heaven.

A High Flyin' Unitrust:   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.

Private Letter Rulings

PLR 9413020 Rawhide Unitrust:   The Service in this PLR approved the transfer of tangible personal property into a unitrust. A rancher desired to give cattle to the trust. Because he is a cash basis taxpayer and has no basis in the cattle, there is no charitable deduction under the Sec. 170(e) reduction for gift of ordinary income asset rule. However, he will be able to bypass recognition of the ordinary gain so long as the trust does not conduct an active business and thereby violate the UBI rules. For this reason the trustee will not be engaging in efforts to "fatten the cattle for market," but rather will merely maintain them and sell as soon as is reasonable.

PLR 9452026 Tangible Personal Property to Unitrust:   In PLR 9452026 the Service allowed the transfer of TPP to a charitable remainder annuity trust. While the intervening interest rule of Sec. 170(a)(3) precludes a current deduction, "an income tax deduction would be allowed under Sec. 170(a)(3) when the trustee sells a musical instrument." The deduction would be determined by multiplying the basis in the TPP, in this case a musical instrument, times the appropriate remainder factor. Because the deduction has been reduced to basis times the factor, this would be a 50% type deduction if the reminder recipient is a public charity.


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