You are at: Planned Giving > For Advisors > Article of Month
Rebecca is a successful entrepreneur. Among her many business endeavors, she often acquires large parcels of property and develops them into commercial buildings or residential structures.
Rebecca has two properties that she is considering selling this year. The first property is a large parcel that she developed and subdivided into 100 separate lots. She very quickly turned around and personally sold 80 of the lots for a substantial profit. The 20 lots that remain have a fair market value of $600,000 ($30,000 per lot).
Rebecca also has an 80-acre parcel that she has owned for 10 years as a passive investment. This parcel could potentially be sold for approximately $2 million.
After hearing about the benefits of a charitable remainder unitrust, Rebecca wonders if she can transfer her 20 lots and 80-acre parcel to fund a unitrust. She likes the idea of using her property to support her favorite charitable organizations while, at the same time, receiving tax savings. In addition, Rebecca has not entered into any binding sales agreements with prospective buyers and, as such, it is still possible to set up a unitrust and avoid prearranged sale problems. Rebecca meets with her advisor, Jack, to discuss how to structure her charitable gift.
Jack explains that the best strategy, in this instance, is to isolate the ordinary income property (the 20 lots) and investment property (the 80-acre parcel) into two separate FLIP unitrusts. Unitrust A will be funded with Rebecca's 20 lots. The total cost basis of the lots is $100,000 and the fair market value is $600,000, resulting in a $500,000 gain. Since these lots are classified as dealer-type property, Rebecca would recognize $500,000 of ordinary income if the lots were sold outside the trust. By selling the lots inside the unitrust, Rebecca will save the ordinary income tax that would otherwise be payable on the $500,000 gain. She will also receive a charitable income tax deduction (equal to the $100,000 cost basis multiplied by the charitable remainder trust factor) and trust income for her lifetime. Note that, because this is dealer-type property, the deduction calculation will be based upon her cost basis, rather than the property's fair market value. The trust payouts, however, will be based on the total value of the trust corpus.
Because Unitrust A will be funded with ordinary income property, Jack explains that when the unitrust sells the lots, the proceeds from the sale will be allocated to tier one for trust accounting purposes. As such, Unitrust A will pay out ordinary income, which will be taxable at Rebecca's income tax bracket of 35%. Therefore, Jack explained that Rebecca's investment propertythe 80-acre parcelshould be isolated in a separate unitrust so that it can pay out partly capital gain income, which will be subject to preferential capital gains rates.
Accordingly, Rebecca plans to fund a second unitrust, Unitrust B, with her 80-acre investment property. The charitable deduction will be calculated based on the full fair market value of $2 million, and Rebecca will be able to avoid the capital gains that she would otherwise have to pay if she sold the real estate. In addition, once the real estate is sold, the capital gain will be allocated to tier two for accounting purposes and the trust can be invested primarily in stocks. Thus, the majority of the trust's payouts will be dividends or long-term capital gain taxable at Rebecca's capital gains rate of 18.8%.
Rebecca appreciates Jack's keen insight in suggesting two separate unitrusts and decides to move forward with this plan. Not only is she able to maximize her tax benefits, she will receive an income stream for life and leave a charitable legacy with her favorite organizations after all payments have been made.
Investor or Dealer? - Gifts of Real Estate and Donor Classification
How to Collect Charitable IRA Beneficiary Designations
IRA Charitable Solutions Part II
IRA Charitable Solutions – Part I
Recent Developments with Donor Advised Funds
© Copyright 2019 Crescendo Interactive, Inc. All Rights Reserved.PRIVACY STATEMENTThis site is informational and educational in nature. It is not offering professional tax, legal, or accounting advice.For specific advice about the effect of any planning concept on your tax or financial situation or with your estate, please consult a qualified professional advisor.