How a Charitable Remainder Trust Can Help Agriculture Producers

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Swan Land Company
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This Article is Provided Courtesy of Chris Nolt

This article will discuss the uses of a Charitable Remainder Trust (CRT) for a farm or ranch owner and answer common questions about CRTs.

What is a Charitable Remainder Trust?

A CRT is a type of irrevocable trust in which you may transfer appreciated property to and retain the right to receive income from for life, or for a term of years, and where any remaining assets in the trust pass to charity at the end of the selected term or the end of the donor’s lifetime.

What are the Benefits of a CRT?

A CRT offers several potential benefits, including:

  1. Avoidance of capital gains tax on sale. Highly appreciated assets such as land can be transferred to a CRT.  Because a CRT is a tax-exempt entity, capital gains tax that would normally be due on a sale, are deferred.
  2. Avoidance of ordinary income taxes on a sale.  Besides the ability to bypass capital gain taxes on the sale of land, a CRT can be used to avoid capital gains tax and ordinary income tax on the sale of livestock, crops, machinery and equipment.
  3. Generate higher retirement income.  Because property sold through a CRT bypasses taxes, the full sales proceeds, undiluted by tax, are invested in the CRT for the benefit of the donor(s).  A percentage of the assets in the CRT are paid to the donor(s) for a selected term of years or for the donor’s lifetime.  Because there is more money to invest, one is able to generate more income for retirement or other purposes.
  4. Charitable deduction.  When a CRT is created and funded with assets, the donor(s) receive a federal income tax deduction for the present value of the future interest that will eventually pass to charity. This deduction is available immediately, even though the charity may not receive anything for many years.  The amount of the deduction depends upon the ages of the donors and the terms of the CRT.
  5. State income tax credit.  Some states offer a tax credit for gifts to a CRT.  In Montana, for example, contributions to a CRT restricted to charitable endowments are eligible for a state income tax credit in the amount of 40% of  the present value of any planned gift made to a permanent endowment of a Montana charity up to a maximum amount of $10,000 per year per taxpayer.
  6. Reduce or avoid estate taxes.  Assets transferred to a CRT are removed from the donor’s estate for estate tax purposes – even though the donor receives income from the trust each year.
  7. Increase inheritance for heirs.  Even though assets remaining in a CRT at the time of the donor’s death pass to charity, it may be possible to actually increase the amount of wealth passed to heirs by using income from a CRT to fund the purchase of a life insurance policy which is owned in an irrevocable life insurance trust (ILIT). 
  8. Support a worthy cause.  Because a charity or charities are named as remainder beneficiaries of a CRT, the assets left in the CRT at the donor’s death, or at the end of the trust term, pass to the charity.  This is a tax-efficient way to leave a legacy of caring.  Even if you are not charitably motivated, the tax-savings of a CRT may still make it worthwhile.

Land Sale Example

If you own land that you purchased for $100,000 that is now worth $2 million and you sell that land without a CRT, you will owe approximately $475,000 in federal and state capital gains taxes, leaving you $1,525,000 to invest.

If you earn 8% on this $1,525,000 and you are in a 45% income tax bracket, you would generate a net annual income of $67,000.  If you live twenty-five years, and the proceeds are reinvested, the total lifetime annual income stream would be worth $2,949,889. 

If you instead sold the land through a CRT, you would be able to invest the full $2 million proceeds, undiluted by tax.  If you generated the same 8% annual return, with an 8% trust payout, the CRT would pay you $160,000 per year for your lifetime and provide you an annual income stream of $88,000 (after payment of income tax of 45%).  If you live twenty-five years and the proceeds are reinvested, the total lifetime annual income stream would be worth $3,868,707.  Additionally, you would receive a charitable deduction when the property is transferred to the CRT of approximately $250,000, depending upon your age, and a large amount of money would pass to charity upon your death.

How High Can the Trust Payout Be?

A question I am often asked when considering the use of a CRT to sell appreciated property is how high the trust payout can be.  Statutory rules prohibit a CRT payout in excess of 50% of the contributed property and mandate that the percentage must be low enough to ensure that the present value of the interest passing to charity upon conclusion of your life (or the selected term) is at least 10% of each contribution to the CRT.  Additionally, other rules require the Trust Payout to be no lower than 5%. 

As a practical matter, the maximum permitted Trust Payout depends upon the government interest rate ("Applicable Federal Rate") at the time of contribution and either the age of the income beneficiar(ies) -- if the Trust Payout is guaranteed for life, or the length of the term -- if the Trust Payout continues for a selected term. 

What is Involved in Setting up and Administering a CRT?

The creation of the CRT involves the determination of the appropriate type of CRT, the drafting of the CRT agreement, and the transfer of assets to the CRT.  Once created, the CRT will be required to file annual tax returns and appropriate distribution amounts must be determined annually.  However, much of this work can be accomplished with the aid of your CPA and the complexity to you can be kept to a minimum. 

While you are not prevented from serving as trustee of your CRT, it is better to name another person because you can lose the tax advantageous of the CRT if it is not properly administered.  You can name either another individual, such as a family member, to serve as trustee or appoint a corporate trustee to serve.  Many people choose a corporate trustee due to their greater investment and administrative expertise.  A charity may also be willing to serve as Trustee (sometimes without charge) if irrevocably named as a remainder beneficiary. 

Regardless of who you select as trustee, however, you can retain the ability to remove and replace the trustee at anytime during the term of the CRT.

Conclusion

A Charitable Remainder Trust can be a valuable tool for agricultural families who wish to sell land and other business assets, bypass taxes on the sale of those assets, generate passive retirement income and benefit charity when they are gone.

 

Chris Nolt is an independent, fee-only registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement.  To order a copy of Chris’s new book: Financial Strategies for Selling a Farm or Ranch, visit Amazon.com or call Chris at 800-517-1031. For more information, visit: www.solidrockproperty.com and www.solidrockwealth.com.