Asset conversion planning

by Shaun Sommerer

Last month this column focused on Charitable Remainder Trusts known widely as CRT’s. This month I will present Part I of an example case study where a CRT is used as part of an asset conversion plan for a couple considering retirement.

A husband and wife have been farming for 40 years. Their estate currently includes $250,000 of fully depreciated farm machinery, $250,000 of inventory, $250,000 of miscellaneous assets, and land valued at $1,000,000. Like many people their age they are now thinking about retirement and shifting their investment posture from asset accumulation to one of conservation and maximizing income. On the personal side they would like to give something back to their parish by giving of their time as well as a portion of their financial resources.

This couple intends to keep the farm and rent it on a cash basis for the time being. They also plan to retain the $250,000 of non-income producing assets and they consider the $500,000 of farm machinery and inventory as potential retirement assets. However, keeping the machinery and inventory in their present form means they are non-income producing.

The couple would like to sell their machinery and inventory; however, they will have to pay recapture and income taxes, of approximately 50% on the sale proceeds. This would leave them about $250,000 to reinvest, much less than they were planning on for retirement. Paying half of the sale proceeds in taxes when they worked so long and hard to accumulate these assets is a difficult proposition to face.

Working with their financial planner the couple have identified the following goals as part of their financial plan:

1) Convert their machinery and inventory into cash while minimizing recapture and income taxes;

2) Create an investment vehicle that will maximize their retirement income;

3) Maximize the inheritance passing to their children and grandchildren;

4) Make a gift to their parish.

For this couple establishing a CRT is the solution to assist them in meeting their goals # 1, 2 & 4. First, they transfer their machinery and inventory into a CRT which they established. Once inside the trust, the trustees can sell the contributed assets and the trust will realize the full value of the sale. By taking this route, the couple will avoid capital gains, depreciation recapture and ordinary income taxes on the property transferred to the CRT for a tax savings of about $250,000. If the assets were sold outside the trust there would be about 50% less to reinvest. Second, the couple have elected to be the income beneficiaries of the CRT meaning they will receive a life-time income from the trust based upon a fixed percentage [must be at least 5%] of the annual trust value. Finally, upon the death of both, the principal remaining in the trust will be distributed as specified by the trust, in this case their parish.

Simply by employing a CRT, this couple have maximized the financial, social and spiritual value of their assets: financially by reducing taxes and increasing their personal cash flow; socially by earmarking the principal to fulfill social needs through their parish; and spiritually by knowing they have been faithful stewards of their assets by gifting the remainder of the trust assets to an institution that reflects their personal values.

Even though a CRT can provide substantial lifetime income for this couple, there is an estate planning tradeoff to be considered. Specifically, the principal from the CRT will ultimately pass to their parish in this case rather than to the couple’s children and grandchildren. So what can be done for the children?

Next month I will discuss how this couple can also meet their goal to provide for their children by establishing an irrevocable life insurance trust.

Note: the example presented is for illustration purposes only and does not constitute a complete financial plan. Always seek counsel from professionals who are knowledgeable and proficient in financial and estate planning.