Friday April 19, 2024
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4.8.4 Sale and Unitrust
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Sale and Unitrust
Asset Sale: The most common way to sell an ongoing business is by selling the assets.
LLC Units Sale: It may be possible for an LLC owner to sell his or her LLC units to a third-party buyer.
Tax Issues: In the case of a unitrust and sale, assets that are sold by the donor outside of the trust will be subject to capital gains tax.
Potential Self-Dealing with Sale of Assets in CRT: After a CRT receives assets from an LLC, the trustee may wish to sell those assets.
Who is a Disqualified Person? Whether someone is a disqualified person with respect to a CRT is determined by facts and circumstances, but generally the LLC itself is qualified.
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Another option for selling limited liability company (LLC) assets or LLC units is a combination sale and unitrust. The sale and unitrust allows an LLC owner to sell a portion of his or her interest in the LLC and offset some or all of the capital gain on the sale with a gift to a unitrust.
Asset Sale
The most common way to sell an ongoing business is by selling the assets. Purchasers of businesses often like an asset sale because the purchaser does not assume any of the seller's pre-existing liabilities and also because the purchaser will have a higher cost basis in the assets purchased and therefore, larger depreciation deductions.
With an asset sale, an LLC owner transfers selected assets to a charitable remainder trust (CRT). Remember that if the LLC is engaged in an active trade or business, the lease option should be used before any assets are transferred to the CRT. Note: rent payments derived from personal property leases will not be excluded from UBIT. Sec. 512(b)(3). If personal property is leased with real property and the rent attributable to the personal property is an incidental amount to the total rents received the rent may be excluded from UBIT. Sec. 512(b)(3)(ii). See GiftLaw Pro 4.8.2. The remaining assets continue to be owned by the LLC. Following the transfer of some assets to the CRT, the LLC owner together with the trustee of the CRT then seeks a buyer for all the LLC assets. Once the assets are sold the proceeds are divided between the CRT and the LLC according to their respective ownership interests.
When the CRT is funded with LLC assets the LLC is the entity that receives the charitable deduction and the income stream from the CRT. Because the LLC is taxed as a partnership, the income tax deduction and the income stream flow through to the LLC owners. It is important to note that the use of the charitable deduction by the LLC owner will be limited to the LLC owner's cost basis in his or her LLC shares. This limitation is the result of partnership taxation rules.
Another item to be aware of is the type of asset that is to be transferred to the CRT. If the asset is depreciable property or an ordinary income asset, then the charitable deduction may be reduced.
LLC Units Sale
It may be possible for an LLC owner to sell his or her LLC units to a third-party buyer. In this case the buyer is taking over the existing LLC and will continue to operate the business.
If desired, the LLC owner can transfer a portion of his or her units into a CRT and keep the rest outside of the CRT. As with the asset sale, the trustee of the CRT and the donor will each sell all their LLC units to a buyer.
There are two rules that may impact this transaction. First, the LLC may be operating an ongoing trade or business. If it is, the LLC could subject the trust to an excise tax.
If a charitable remainder trust (CRT) is an LLC member, there may be an excise tax on income. See Newhall v. Commissioner. With LLC assets from an active trade or business in the charitable remainder trust, there will be tax on the UBI. The trust will be subject to 100% excise tax on the unrelated business income. Sec. 664(c)(2)(A). Since a unitrust with unrelated business taxable income does not lose exempt status, an active LLC business asset may still be transferred to the trust and sold fairly quickly. If the asset is sold quickly, a donor may receive the capital gains bypass benefit with a modest cost for the 100% excise tax on trust unrelated business income.
The second rule is that the property owned by an LLC should not be subject to debt. Because the LLC is a flow-through entity, any debt by the LLC may be attributed to the LLC owner. The debt on such property is deemed to be an obligation of the donor. Any possibility that the debt could be paid by the CRT would violate the rule that allows only a unitrust or annuity trust payment to be made to the non-charitable beneficiary.
Tax Issues
In the case of a unitrust and sale, assets that are sold by the donor outside of the trust will be subject to capital gains tax.
To determine the capital gains tax, the donor must allocate his or her basis in the assets or units between the assets given to the CRT and the property held outside of the CRT. The amount realized from the sale will likewise be apportioned between the CRT and the donor's interest held outside of the trust. The difference between the amount realized by the donor with respect to property held outside the trust and the basis allocated to that property will be recognized as capital gain.
The capital gain liability can be partially or entirely offset by the charitable deduction produced by the gift to the CRT. This "zero-tax" amount can be calculated using the Sale and Unitrust program in Crescendo software.
When using the zero-tax option, it is important to remember that a donor's income tax deduction will be limited by his or her adjusted gross income (AGI). Where a trust is funded with an appreciated asset, the donor's ability to use the deduction in the year of the gift is limited to 30% of adjusted gross income. If a donor has an AGI of $100,000, the donor can use the deduction for up to $30,000 ($100,000 x 30%). Therefore, if the zero-tax scenario produces a higher deduction than the donor can use, he or she will have to carry over any excess deduction into the following tax year. The donor has a total of six years to use the charitable deduction. It is important to inform the donor that the transaction may not be zero tax in one year, but rather zero tax in as many years (up to six) as it takes to use all of the charitable deduction.
Example 4.8.4
Rob and Rita Rental have been in real estate for many years and as a result own many rental properties. Because Rob and Rita were concerned with liability in the event someone were injured on one of their properties, they placed all of the properties in an LLC years ago.
Rob and Rita are hoping to retire and would like to reduce the real estate holdings in the LLC without paying a large capital gains tax. Rob and Rita have a couple of "problem properties" worth $500,000 each that they would like to sell. Both of those properties have debt totaling $200,000 and thus using a unitrust is not possible.
Because Rob and Rita would really like to sell their properties utilizing a unitrust, the LLC takes out a loan of $200,000 on one of the rentals it is going to keep. The $200,000 from the loan is used to pay off the debt on the two rentals to be placed in the unitrust. Rob and Rita, however, would like to receive cash when the properties sell so they can pay off the $200,000 loan.
Once the properties are debt-free, the LLC transfers an undivided 80% interest in the properties to the unitrust. The LLC continues to hold an undivided 20% interest in the properties. When the properties are sold, the unitrust will receive 80% of the proceeds and the LLC will receive 20% of the proceeds. The LLC can then pay off the $200,000 loan.
The trust, with a 7.5% trust return and a 5% payout, will provide the LLC with an income stream of more than $1 million over 20 years. The trust also provides the LLC with an income tax deduction of almost $300,000.
Potential Self-Dealing with Sale of Assets in CRT
After a CRT receives assets from an LLC, the trustee may wish to sell those assets. Self-dealing rules prohibit the trustee from selling the assets back to the LLC or to any other disqualified person. As a result, prior to accepting a gift of the LLC assets, a CRT trustee may wish to consider whether or not the trust will be able to sell the assets to an unrelated party. (Note that a charity is not subject to self-dealing restrictions. Thus, with an outright gift to charity, it may sell LLC assets back to the donor so long as the transaction is reasonable, for fair market value and not pursuant to a prearranged plan).
After an LLC contributes assets to a CRT, the LLC and CRT each own assets that later may be sold to a single purchaser. If the LLC and CRT jointly list and sell those assets to a third-party purchaser, there is some concern that self-dealing might occur because the LLC benefits from the joint sale. It is generally agreed that in this situation any benefit to the disqualified person will be incidental or tenuous and therefore not self-dealing. Reg. 53.4941(d)-2(f)(2).
Who is a Disqualified Person?
Whether someone is a disqualified person with respect to a CRT is determined by facts and circumstances, but generally, the LLC itself, anyone who owns more than 20% of the LLC, a trustee of the CRT or a lineal descendant or spouse of any disqualified person are all disqualified. Sec. 4946.
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Case Studies on Sale and Unitrust
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.
An Installment Sale Transfer without Capital Gain Taxation:
Richard Andrews, age 60, and his two college buddies decided to purchase a 10-acre parcel of property on the outskirts of San Francisco 30 years ago. Their idea at the time was, "Let's buy the property and use it as our retirement."
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Private Letter Rulings
PLR
200043047 Unitrust May Invest Through Family LLC:
Donors created 15 charitable remainder unitrusts (CRUTs) for their three children and 12 grandchildren. Subsequently, the family established a limited liability company (LLC) to invest family assets. The 15 CRUTs propose to invest in the LLC. The benefits will include diversification, pooling of assets, obtaining economies of scale and access to investments with higher minimums.
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