The Charitable Deduction
Inventory may be transferred to a charitable remainder unitrust. However, there are two important differences to be aware of when transferring inventory into a charitable remainder trust. The two differences affect the charitable deduction.
Timing of Deduction - Intervening Interest
First, the transfer of assets into a charitable trust creates an "intervening interest" under Sec. 170(a)(3). This section was created to preclude deductions for gifts of art when the donor wished to retain the use of art for a period of time. The charitable deduction is allowed only after the donor relinquishes the art and transfers it to the charity.
With a charitable trust, Sec. 170(a)(3) delays the income tax deduction until the asset is sold. At the time of sale, there is no longer an "intervening interest," since the asset has been converted to cash, and the deduction may be claimed. In such a case, the value of the gift is determined on the date of sale (rather than the original date of transfer). Reg. 1.170A-5(b), Example 2.
Cost Basis Used as Deduction - Unrelated Use
The second difference is due to the related use rules. When tangible personal property or inventory is transferred to a charitable remainder unitrust, the asset is always treated as having an unrelated use. Therefore, the deduction is calculated starting with cost basis rather than fair market value.
Other Tax Benefits
While a donor funding a trust with inventory is allowed only a reduced deduction, the donor does not have to report any income from the sale of the inventory. This can be beneficial to the donor for other tax reasons such as employment tax.
Example 4.5.4A
Bob Smith is a cattle rancher. Bob is nearing retirement and would like to sell off all of his cattle. He has always been very charitable, but is unable to make an outright gift of the cattle because he needs to receive an income stream to supplement his other retirement income. The gift planner at Bob's favorite charity told him about the possibility of using his cattle to fund a charitable remainder trust.
Because Bob is a cattle rancher, the cattle are inventory to him. If he transfers the cattle into a unitrust, Bob's deduction is limited to his cost basis. Because Bob has raised the cattle from birth and has written off the expenses of raising the cattle, he has a zero cost basis. Therefore, if Bob uses the cattle to fund a unitrust, he will not receive a charitable deduction.
Bob's unitrust income stream, however, will be based on the fair market value of the cattle at the time they are contributed to the unitrust. If the cattle's fair market value at time of contribution is $100,000 and Bob has a 6% payout, he will receive an income stream of $6,000 in the first year, assuming his trust was funded on January 1.
Even though a trust funded with inventory does not have the same charitable deduction benefits as a trust funded with a capital asset, there are good planning opportunities for some donors.
Example 4.5.4B
Gene Grain is a wheat farmer. Gene had a bumper crop this year and thus, has extra silos of wheat. Gene is considering using the wheat to fund a charitable remainder unitrust for himself and his spouse. The wheat has a fair market value of $100,000. Because Gene expensed all the cost associated with growing the wheat he has a zero cost basis in the wheat.
If Gene transfers the wheat to a CRUT, he would not receive any charitable deduction because his cost basis is zero. His payout from the trust, however, would be based on the fair market value of the wheat. If the unitrust payout were 5%, Gene and his spouse would receive $5,000 in the first year from the CRUT, assuming his trust was funded on January 1.
Even though Gene does not receive a charitable deduction, he is very happy because he does not have to include the value of the wheat in his income.
