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Charitable Remainder Trusts - Farmland Case Studies Thumbnail

Charitable Remainder Trusts - Farmland Case Studies

Posted by John Posey

A charitable remainder trust could be a particularly compelling instrument if you: 1) own highly appreciated assets, 2) are willing to trade the liquidity of those assets for an income stream, and 3) are charitably inclined. Depending on the kinds of assets you plan to gift – especially if you already have plans to leave specific assets to charity - a charitable trust can be a very useful tool for you, your family, and the charities you support. You may be missing out on some significant opportunities that a charitable remainder trust could offer, particularly if you would like to gift appreciated assets for full market value but still need or want the income stream those assets could generate. These opportunities include continued income for life, the possibility of a significant charitable tax deduction, and/or the ability to spread out and reduce income tax implications over a number of years, all while supporting charitable causes.

In middle America, it’s not uncommon to see ownership in an appreciated, low-basis asset like farmland (i.e., low original purchase price - high potential capital gain) that’s been held for decades. Often selling highly appreciated assets during our lifetime is discouraging given the capital gain tax implications to do so – often gains realized upon sale are subject to capital gains tax which could take up a substantial bite out of your proceeds. You may be familiar with the step-up in basis rule that has the ability to avoid the capital gains tax on non-retirement assets (i.e. – non-IRA, non-annuity assets) when left to heirs, which encourages many to hold highly appreciated assets for their lifetimes to avoid tax consequences even if there is a desire or prudent reason to transfer ownership. A charitable remainder trust could be a great solution in this type of scenario if the owner’s goal is to continue to receive income from the value of the asset, reduce taxes, and ultimately pass on the value of the asset to charity. You could almost say it’s like an alternative to other tax-advantaged transactions like a 1031 exchange or installment sale, however, charitable intent is a key distinction - the remaining assets are directed to charity following death. Additionally, you will only receive a defined income stream which may be fixed or variable depending on the type of charitable remainder trust you choose – you have no other access to the trust assets and it is irrevocable. These are key features of a charitable remainder trust and why it’s not always a good option.  

With all that in mind, if you were going to sell highly appreciated assets for fair market value and could retain the income stream where the accessibility of the lump sum proceeds is not vital, why not consider a charitable remainder trust? You keep an income stream for life or a defined number of years and likely receive a sizeable tax deduction, a buyer can make a valuable purchase, and a charity will ultimately benefit from your generosity. It can create a winning opportunity for all involved.

I’ve seen a couple of scenarios involving farmland where a charitable remainder trust was a great solution for the owner, the charity, and the family farming the ground. In the first situation, a couple owned 160 acres of cropland that they inherited from one of their parents and the couple owned the land for several years. They received cash rent over the years and extended family actively farmed and rented the ground. The couple wanted to continue to receive income from the asset over their lifetimes to support their income needs and desired to leave the value of the asset to charity. Essentially the couple created a charitable remainder unitrust and subsequently deeded their jointly owned 160 acres to the charitable trust. The charitable trust then sold the cropland at fair market value to the family farming the land. Several good outcomes resulted: 1) Ownership was transferred and a large capital gain was avoided 2) The couple received a charitable tax deduction and can carry it forward for 5 years 3) The couple retained an annual income stream of 5.5% of the charitable trust assets/farmland sale proceeds for their lifetimes (which happened to represent more than their previous cash rent), 4) The family purchasing the farmland continued their operation uninterrupted and preserved the land, and 5) The charity inevitably receives a sizeable gift of easily transferrable cash and securities that can be liquidated or maintained in service to the charity.

In another scenario, a widow received 80 acres of cropland upon their spouse’s passing. The deceased spouse had farmed the land with a sibling and the widow continued to own and cash rent the land to the spouse’s family for many years. The widow desired to leave the value of the cropland to their church so her estate plan instructed the cropland to be left to their church upon her passing via her Last Will and Testament. Using a charitable remainder trust in place of her Will became a compelling alternative given the following benefits: 1) The land can be transferred to a charitable remainder trust where a large capital gain can be avoided and alternatively, a material tax deduction would be realized by the owner. Leaving the land to charity via the Will would provide no tax benefit representing a lost tax saving opportunity. 2) The family farming the land would be given the opportunity to purchase and preserve the farm within the family’s operation without risk or interruption upon the owner’s passing, 3) The widow would maintain an annual income stream of roughly 5% of the charitable trust assets for their lifetime and 4) The church will ultimately receive cash and securities that can be easily transferred and liquidated rather than receive the responsibility of either managing or liquidating the farmland.

These two situations are slam dunks for using a charitable remainder trust. One other charitable remainder trust scenario I know about involves farmers preparing to sell their last crop upon retirement. The main issue is crop income is often realized in the year following harvest with little to no corresponding expenses to offset the income, consequently, a big tax bill looms. A charitable remainder trust could be used to spread out the crop income over several years and result in a significantly lower tax burden. (Other alternatives would be to try to spread crop income over a couple of years or use deferred payment contracts.) Essentially the crop is assigned and donated to the charitable trust then subsequently sold - the farmer only pays tax on an income payment received each year (over a defined number of years). One key feature in this scenario is that grain is considered an “ordinary income” asset which means no tax deduction to the farmer for the donation of grain in this case - the charitable deduction is only available for the amount of tax basis still in ordinary income assets such as grain, machinery, and livestock. The main tax benefit is the ability to spread out the income over several years (rather than over a year or two) and presumably lower your tax liability by doing so. Grain is typically zero basis because you already deducted the related expenses in the prior year. The tax basis in many ordinary income assets is often low to zero because it’s reduced or removed through previously claimed expenses, depreciation, and deductions. Alternatively, farmland is considered a “capital gain” asset – a charitable deduction is allowed based on the fair market value of capital gain assets.

Robert Moore of the Ohio State University Extension Farm Office has written a piece on using charitable remainder trusts as a retirement strategy that is worth reviewing for more resources on this subject. He has suggested in their bulletin that donating farmland to a charitable remainder trust is rarely considered, but I think the cases I mentioned above could apply to many people, particularly those living in farm communities and greater rural America. Holding appreciated farmland until death to avoid the possibility of capital gains tax coupled with the desire to gift the farm to family is the most common approach for good reason – it helps family farms thrive and endure from one generation to the next. However, if you are in the fortunate position of not being financially dependent on the value of some of your land or other assets and could live comfortably on just the income, a charitable remainder trust is worth considering. Specifically, if you have neighbors or remote relatives you’d like to sell to while avoiding material capital gains tax implications, a charitable remainder trust could be a great solution - familiarity with the rules around family member transactions is important and we’ll touch on that next.

An important point to note is the ability or lack thereof to sell assets from your charitable remainder trust to family members. A charitable remainder trust’s ability to sell assets to family members is contingent upon a few factors, such as the provisions of the trust agreement, and applicable state laws and regulations governing charitable remainder trusts set forth by the Internal Revenue Service (IRS). Consult an experienced estate planning attorney on your specific situation before completing any transaction that is expected to involve family. With that in mind, the IRS would consider your immediate family non-qualified persons and would define a member of your family as follows: A member of the family includes any spouse, ancestors, children, grandchildren, great grand­children, and spouses of children, grandchild­ren, and great grandchildren.  A brother or sister of an individual is not a member of the family for this purpose.  A legally adopted child of an indi­vidual will be treated as a child by blood. In other words, you can’t sell to your immediate family but extended/remote family (think siblings, cousins, nephews, uncles, etc.) would qualify as I understand - yet again, seek out a professional in estate law in your area. You are on the right path if the sale of trust assets is conducted at fair market value, does not involve immediate family or excessively benefit the donor or other disqualified persons, and is consistent with the trust’s charitable purpose.

It's also worth noting that higher interest rates can make certain charitable remainder trust designs more compelling. In particular, the current Section 7520 rate is north of 5% which is used to determine the maximum allowable income payment of a charitable remainder annuity trust.  The calculation is a bit complex, but the key point is the higher the Section 7520 rate, the higher the maximum income payment to the donor. For example, if the Section 7520 rate is less than 2% (as it was for many years), you would not receive your contribution back in the form of annual annuity payments over a 10-year term. The higher the interest rate, the more attractive charitable remainder annuity trust design becomes. Paul Nieffer of the Farm CPA Report has written some good content on this topic you can find here, Higher Interest Rates Make CRTs More Attractive.

Another reason a charitable remainder trust might be attractive is transferring assets to it removes those assets from your estate. This could help avoid some estate and inheritance taxes. Do you know the difference between estate and inheritance taxes? Read this for an overview: Estate vs. Inheritance Taxes - What's the difference?

If you are in the situation of owning highly appreciated assets coupled with the need for income, you might find using a charitable remainder trust to be a wonderful opportunity to leave a legacy of supporting charity while generating an income stream. The minimization of taxes is a nice bonus too.  

Advisory services offered through Plains Advisory LLC, an investment adviser registered with the State of Nebraska. Insurance products and services are offered and sold separately through John Posey, a licensed insurance agent. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Any information provided is designed to provide general information on the subjects covered, it is not, however, intended to provide specific legal, tax, financial or investing advice and cannot be used to avoid tax penalties or to promote, market, or recommend any plan or arrangement. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness.  All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.