UJA-FEDERATION
OF NEW YORK
35TH
ANNUAL NEW YORK ESTATE, TAX
AND
FINANCIAL PLANNING CONFERENCE
SOPHISTICATED
PHILANTHROPY
CHARITABLE
GIFTS OF HARD TO SELL ASSETS
INCLUDING
COLLECTIBLES
AND REAL ESTATE
Wednesday,
September 14, 2004
MARRIOTT
MARQUIS
PHILIP
T. TEMPLE, ESQ.
McCarthy,
Fingar, Donovan, Drazen & Smith, LLP
White
Plains, NY
GIFTS OF TANGIBLE PERSONAL PROPERTY
1. Deductibility of gift of tangible personal property (for example, art or other collectibles) deductible at fair market value only if gift is deemed as being made for a related use. If gift is deemed made for an unrelated use, gift is limited to cost basis.
2. See special rule of Code Section 170(a)(3) below.
3. Transfer
of Tangible Personal Property to Remainder Trusts. Is A Puzzlement!
A. Code
Section 170 (a) (3):
Future Interests in Tangible Personal Property -- For purposes of this section, payment of a charitable contribution which consists of a future interest in tangible personal property shall be treated as made only when all intervening interests in, and rights to the actual possession of enjoyment of, the property have expired or are held by persons other than the taxpayer or those standing in a relationship to the taxpayer described in section 267(b) or 707(b). For purposes of the preceding sentence, a fixture which is intended to be severed from the real property shall be treated as tangible personal property.”
B. The Krugerrand Rulings:
(1) LTR 9225036 held that appreciated in value Krugerrands are more like money than collector’s coins (tangible personal property), thus the deduction for a transfer to a CRT would be based on full fair market value -- not cost. The Service also said that funding an otherwise qualified CRT with Krugerrands would not disqualify the trust. And, since the coins were not tangible personal property, the rules of IRC Section 170 (a)(3) won’t apply.
(2) A second Kruggerand ruling submitted some nine months later, which was withdrawn because of the tax payer’s death, appeared to indicate that IRS had changed its mind.
C. LTR 9452026 held that funding a CRT with an appreciated musical instrument is OK.
(1) IRS did not rule on the qualification of the trust referring to its Revenue Procedures containing specimen CRT documents.
(2) Since the instrument is tangible personal property, no income tax
deduction is allowed under IRC Section 170 (a) (3). The deduction is allowed only when it is sold.
(3) It’s an unrelated use gift and, therefore, the income tax contribution deduction is based on cost, not fair market value.
1. BACKGROUND
A. Donor, a widower, had amassed a significant collection of Italian baroque
art with a estimated fair market value of over $30 million, and the top
collection of its kind in private hands.
B. Donor’s strong desire was to keep the collection intact.
C. He also wished to take care of his only child, her husband and their two
children.
D. The family was concerned with the potential substantial estate tax bite
which would require an auction sale of the art to pay estate taxes and
estate expenses, since the art constituted the bulk of the estate.
E. Donor had engaged in preliminary discussions with an art museum which
indicated a strong desire to acquire the collection.
2. THE ADOPTED PLAN
A. The art was transferred to a revocable trust of which Donor and his daughter
were trustees with daughter’s husband as successor trustee.
B. At his death (or alternatively, at his being declared judicially incompetent),
the trust became irrevocable and its assets -- the art -- were divided into two
equal shares:
(1) The first share was placed into a net income with makeup unitrust
paying a unitrust amount of the lesser of (i) 5% of the fair market
value of the trust assets, as revalued annually and (ii) the actual
unitrust income. Any deficiencies in distribution from an earlier
year would be made up in any later year where the trust income
exceeded the stated 5%. The trust term was 20 years; the beneficiary
was Donor’s daughter or, if she died during the 20 year trust term,
her children. The trustees have the power to name the charitable
remainder organization.
(2) The second share was placed into a charitable lead annuity trust
paying an annuity amount equal to 8% of the initial fair market
value of the assets placed in trust; the trust term was 20 years;
the charitable beneficiaries were to be selected by the trustees;
the trust remainder was payable to Donor’s daughter or, if she
was not then living, to her children.
C. The plan would:
(1) Generate substantial estate tax charitable deductions for the remainder
and lead charitable interests;
(2) By having the ability to designate the charitable beneficiaries, give the
trustees leverage to negotiate;
(3) Generate significant income for daughter or her children;
(4) Generate a large distribution of the lead trust remainder to daughter or
her children.
(5) Would keep the collection intact if a museum purchaser could be found.
3. IMPLEMENTATION
A. Donor unfortunately died untimely -- approximately eight months after the trust
agreement was signed.
B. Counsel for the estate took the following steps:
(1) Obtained admission of the Will to probate;
(2) Retained the services of special legal counsel -- expert in dealing with
art in trusts and estates;
(3) On advice of special counsel, the estate obtained an appraisal of the
art from Sotheby’s and began the process with IRS of obtaining an
advance valuation of the art by the IRS Art Advisory Panel -- before completing and filing the Federal and New York State Estate Tax
Returns - - a procedure that had never been done before.
C. Other steps:
(1) Because the value of the art represented over 90% of the total estate value,
arrangements were made with Sotheby’s to borrow the necessary funds to
pay estate tax -- significantly reduced by the charitable deductions.
(2) Negotiations began by the estate’s financial advisors and regular and special counsel with a University Art Museum to purchase the art from the trusts; it being understood that the University would be designated as charitable beneficiary. The Art Museum was in the process of building a new building for the Museum and it believed that acquisition of the
collection would give it instant credibility in the art world and the collection would be the cornerstone of the new building.
4. THE HAPPY ENDING
A. Agreement was reached with the University to sell the collection for its true
fair market value.
(1) Twenty percent went to the revocable trust which used the proceeds
to pay administration and other expenses and to pay back the Sotheby’s loan.
(2) Forty percent went to the unitrust, paid with tax exempt paper issued by a new supporting organization for the University; generating a tax free income stream to daughter which included, of course, the make up of the deficiencies from the date of death.
(3) Forty percent went to the charitable lead annuity trust with interest and
principal payments sufficient to satisfy the annuity amount payable
to charity while leaving an excess to reinvest and create a substantial remainder for the daughter or her children.
B. The entire collection goes to the University Art Museum with the bulk to be
hung in the new building and part to be used for educational purposes.
C. The University is designated charitable beneficiary and since it will now receive
the remainder of the unitrust and the annuity amount stream from the lead trust,
it’s cost of acquiring the art has been significantly reduced. It receives over
$30,000,000 in art value at a cost of $10,000,000 to $14,000,000 in present
value terms.
1. Real estate represents approximately 50% of total individual wealth; thus, important potential for charitable gifts.
2. Many kinds of real estate interests; know the names and rules, for example: whole fee interests; partial interests (undivided interests, life estate and remainder; joint tenancy; tenancy in common).
3. Income tax charitable contribution deduction.
A. Limit on charitable deduction for appreciated real estate gifts is 30% of adjusted gross income with five year carryover for any “excess” contribution - - up to 30% of adjusted gross income in each carryover year until exhausted.
B. If you can’t use entire gift, consider contributing partial or undivided interest over a period of years or making the election to reduce the amount of the gift by the appreciation so that the ceiling increases to 50% of adjusted gross income.
4. Transfer of Encumbered Property to Remainder Trusts and as Outright Gift.
A. Mere transfer of mortgaged property is deemed bargain sale. Reg. Section 1.1011-2(a)(3).
(1) IRS has said Reg. Section 1.1011-2(a)(3) applies to CRT. Rev. Rul. 81-163, 1981-1 C.B. 433.
(2) Gain is for difference between amount of debt and allocated adjusted basis; not limited by property's fair market value.
B. LTR 9015049. CRT disqualified if funded with mortgaged property.
(1) Facts. D planned to fund charitable remainder unitrust with income-producing real estate. Trustee would make regularly scheduled payments on mortgage, but D would remain personally liable for the debt.
(2) IRS rules. Trust won't qualify. Charitable remainder trust must function exclusively as one from its creation. It isn't charitable remainder trust - indeed, it isn't even deemed "created" - as long as donor treated as owner of entire trust under the grantor-trust rules. Reg. Section 1.677(a)-1(d) provides that donor is treated as owner of trust whose income is or may be applied in discharge of donor's legal obligation. Because D would be treated as owner of entire trust, it wouldn't be deemed "created," and thus wouldn't qualify as charitable remainder unitrust.
(3) Earlier rulings (i.e. LTR 8931023).
C. Possible ways to avoid issue:
(1) If outstanding mortgage is small, you may be willing to satisfy it before transferring property to trust.
(2) Sometimes the lender may be willing to release mortgage if you can substitute other security for indebtedness.
(3) You could sell undivided interest in property to charity (reporting capital gain on any appreciation attributable to that interest). Then you could use sale proceeds to satisfy mortgage, and transfer unencumbered property to charitable remainder trust. Charity would have to take care not to pay more than fair market value for undivided interest - and fractional interests in property may have to be discounted to reflect the unwieldiness of a co-tenancy arrangement. Naturally, charity would first have to be sure charitable remainder is large enough to make it all worthwhile.
5. Consider the following types of trusts or other split interest arrangements:
A. Unitrust agreements.
(1) Standard Unitrust -- pays stated percentage (at least 5%) of net fair market value of trust assets, revalued at least annually, out of income and, if income is insufficient, out of principal. Excess income is retained in trust.
(2) Net Income With Makeup Unitrust -- pays lesser of (i) stated percentage of annual net fair market value and (ii) actual trust income. Deficiencies in distributions from an earlier year are made up in any later year in which trust income exceeds stated percentage. Then excess income retained in trust.
(3) Net Income, No Makeup Unitrust -- pays lesser of (i) stated percentage of annual net fair market value and (ii) actual trust income. Deficiencies in distributions from an earlier year are not made up. Excess income is retained in trust.
(4) Hybrid agreement (the “Flip” unitrust). Net income unitrust becomes standard unitrust on sale of , i.e., closely held corporate stock. First, unpublished PLR said O.K. Then, IRS said it doesn’t work. PLRs 9506015 and 9516040. Now Final §664 Regs again says O.K.
(5) Some Specific Items Regarding Nimcruts.
(a) Excess income in earlier year cannot be used to make up deficiency in later year.
(b) Provision for treating post contribution realized gain as income in net income unitrust.
(c) What is income? Generally state law governs. Be careful of special situations; i.e., assets such as timber; assets that have periodic large amounts of income.
(d) Net income provision does not change calculation of charitable deduction for income, gift or estate tax purposes.
B. Annuity trusts.
(1) Trust where annuity amount couched in terms of stated dollars; trustee directed to pay X dollars a year out of income and, if income is insufficient, out of principal. Any excess income is retained in trust.
(2) Trust where annuity amount couched in terms of a percentage of initial fair market value of assets transferred to trust. Once amount determined, stays constant for trust term.
(3) Unlike unitrust, cannot make additional contributions to annuity trust.
C. Charitable lead trusts.
(1) Donor can avoid tax on income paid to charity, but the trust must not provide reversion for donor or spouse. Trust should be lead unitrust or lead annuity trust. Otherwise, value of charity's income interest will be subject to Federal gift tax. And, if there is a reversion and donor dies before property reverts to him, there will be no estate tax charitable deduction.
(2) Main drawback of law is that donor cannot get income tax charitable deduction unless trust so drawn that he is taxed on income paid to charity. Thus, except for very wealthy individuals, short-term charitable income trust created during lifetime is generally not advantageous. Some create trust with tax-exempt bonds so that income, while reportable, is not taxable.
(3) Lead trusts paying an income stream to charity are advantageous when created by donor's will. Estate tax charitable deduction allowed for value of income paid to charity under lead trust created by donor's will. To get estate tax deduction, income interest must be guaranteed annuity (lead annuity trust) or fixed percent distributed yearly of net fair market value of trust assets, determined yearly (lead unitrust).
D. Gifts of personal residence with retained life estate.
(1) Charitable deduction (for income, gift and estate tax purposes) allowed for gift of remainder interest in real property (not made by transfer to charitable remainder unitrust, annuity trust or pooled income fund trust) only if remainder interest is in personal residence or farm.
(2) Life tenant (often donor) must maintain property --- pay real estate taxes, insurance premiums and for ordinary repairs.
6. Bargain Sale.
A. Real estate is sold to charity for below fair market value; difference between fair market value and sales price is charitable contribution deduction.
B. Donor’s cost basis is allocated on a pro rata basis between sale and gift portion. The gain attributable to the sale portion is realized by the donor; the appreciation attributable to the gift portion is not taxed.
C. Intention to make a gift should be well documented.
7. Gift of Land for Conservation Use.
A. Gift of lease, option to purchase or easement as to real estate that is granted in perpetuity qualifies for the charitable deduction as long as the gift is made exclusively for conservation purposes. See Code Section 170(f)(3)(B)(ii).
B. Value of easement is its fair market value on date of gift. If there is no meaningful record of market place sales, then the value of the easement and, thus, the deduction equals the difference between the pregift fair market value and the post gift fair market value of the entire property.
C. No deduction allowed if the grant of the easement may have no material effect on property’s value or may enhance, rather than reduce, property’s value. Regulation Section 1.170A-14(h)(3)(ii).
D. The amount of basis that is allocable to the qualified conservation interest is in the same ratio to total basis as to the fair market value of the contributed interest bears to the fair market value of the property before the gift.
1. Valuation -- General Rules.
A. Basics. If a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution... fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.
B. Comparable sales.
(1) Comparable sales technique (also known as "market data method") most useful when donated property similar to other property available on open market.
(2) Appraiser locates several similar items -- called "comparables" -- that were sold or available for purchase near time of donation.
(3) That gives ballpark figure. Then value increased or decreased, depending on how donated property stacks up against comparables.
C. Capitalization of income.
(1) If asset generates income, value can sometimes be appraised by estimating how much income it can be anticipated to earn.
(2) Then match to market rates.
D. Replacement cost.
(1) This method most often used when property to be valued is unique and isn't expected to generate income.
(2) Because replacement cost represents value of brand-new asset, adjustments may be made to reflect depreciation on property before its donation.
E. Subsequent sales.
(1) Often, charities that have no immediate use for donated property sell property and use sales proceeds for charitable endeavors. Although sale price of donated asset is not conclusive evidence of fair market value, IRS and the courts generally find it very persuasive.
(2) Indeed, new reporting requirements for certain contributed property sold within two years of gift show how probative Congress finds that information.
2. Form 8283: Appraisal summary.
3. Form 8282: The "tattle tale" form.
4. Appraisals.
A. What must be appraised?
(1) Property gifts (other than money and publicly traded securities) if claimed or reported value of property exceeds $5,000. To determine whether $5,000 threshold crossed, only part of gift claimed as charitable deduction counts. Thus, if land worth $25,000 is placed in charitable remainder unitrust, appraisal requirements apply only if charity's remainder interest more than $5,000 and donor claims income tax charitable deduction.
(2) What is "qualified appraisal"?
(a) Qualified appraisal can be done any time from 60 days before donation up until due date (including extensions) for return on which donor reports or claims gift; post-donation appraisals are okay.
(b) Regulations require qualified appraisal to give following information:
(i) Description of property in sufficient detail for person who is not generally familiar with type of property to ascertain that appraised item is property contributed.
(ii) In case of tangible property, its physical condition.
(iii) Date (or expected date) of contribution to donee-charity.
(iv) Terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of donor (or donee) that relates to use, sale or other disposition of contributed property; includes, for example, terms of any agreement or understanding that –
(A) Restricts (temporarily or permanently) donee-charity's right to use or dispose of donated property;
(B) Reserves to, or confers upon, anyone (other than charity or organization participating with charity in cooperative fund-raising) any right to income from donated property or possession of property - including right to vote donated securities, to acquire property by purchase or otherwise, or to designate person having income, possession, or right to acquire; or
(C) Earmarks donated property for particular use.
(v) Name, address and TIN of qualified appraiser (or appraisers) and - if qualified appraiser is a partner in partnership, employee of any person (whether individual, corporation, or partnership or independent contractor engaged by person other than donor - name, address and TIN of partnership or person who employs or engages qualified appraiser.
(vi) Qualifications of appraiser who signs appraisal, including appraiser's background, experience, education, and membership, if any, in professional appraisal associations.
(vii) Statement that appraisal was prepared for income tax purposes.