Taxlink by Andy Biebl

QUESTION:

I read your article in the October Progressive Farmer involving a grain producer who created a Charitable Remainder Trust (CRT), sold grain, and took back an annuity to spread out the income taxes and eliminate the self-employed Social Security tax. We have a breeder hen farm with a sale contract that will close soon. Is it possible to follow the same method to minimize some of the taxes, which are projected to be about $150,000? Some of the income is ordinary from prior depreciation and some is capital gain. The farm is nearly 100% depreciated, and we are in our 70s so are not interested in another Section 1031 rollover into other real estate at our age.

ANSWER:

A CRT can accept virtually any asset from a donor, but a key point is that we must be transferring an unsold asset that is then disposed of by the CRT. The CRT needs to actually conduct the sale to be tax-free; the CRT then invests the proceeds and pays the term annuity to the grantor of the CRT. Your question indicates that you have a sale contract and you mentioned a closing date. That suggests that the sale is set and just awaiting closing. The IRS view would be that the sale had actually been completed by you and the sale proceeds assigned to the CRT; this would not avoid the immediate taxation. Also, if a significant portion of your gain is at capital gain rates, the CRT would not have been advisable. The ordinary income payments come first, and the capital gain portion, taxed at lower rates, is the last portion of the annuity.

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QUESTION:

Can someone set up a CRT without retiring? As an example, could I transfer unsold grain into a CRT and stretch out the payments, even though I am continuing to farm? And how much does it cost to set up a CRT?

ANSWER:

Yes, it is possible to use the CRT deferral technique without retiring. On several occasions, we have had clients take this action where grain prices are very high and it makes great business sense to sell, but from a tax standpoint it is better to stretch the payments over multiple years rather than push up the tax bracket currently.

The cost is a variable, depending on the types of assets transferred and your attorney fees to draft the documents. The IRS has issued sample pre-approved CRT documents, which makes it easier for the attorney (see Rev. Proc. 2003-54). And if it is a simple bill of sale to transfer unsold grain, in addition to the CRT document, it may not be very complicated -- perhaps $2,000 -$3,000. You will also need a trust department to administer the CRT and issue the payments over the specified term of years. And either that trust department or your tax preparer will need to prepare the annual information return for the CRT, reporting the annual income payout results to both the IRS and to you, as the recipient of the annuity payment.

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QUESTION:

Who controls the CRT during the term of years, the farmer or the charity that will receive the residual? And how is the money invested over this period?

ANSWER:

Technically, the trustee of the CRT controls the trust. That party's responsibility is managing the investments, making the annual payment under the terms of the trust instrument, and at the end of the term moving whatever residual remains to the charity. In many of the CRTs that we use for retiring farmers, the charity is unaware of the existence of the CRT until the CRT term expires and the charity receives the residual.

Some larger charities will have the ability to assist in establishing a CRT, with the obvious expectation that the charity is the residual beneficiary. But those are often designed to move a significantly greater portion than the 10% statutory minimum to the charity. In almost every case involving a retiring farmer, the CRT document is drafted by the grantor's attorney, and designed to maximize the income tax benefits to the retiring farmer/grantor. And often, there may be several charities designated as the residual beneficiaries (e.g., one-half to my church and one-half to our local hospital).

The investments are made with an eye to the annual payments required to the grantor. In a 10- or 15-year CRT, some of the investments can be long term (say stocks or mutual funds), as a portion of the payments are not due for many years. But a portion of the investments should be liquid, lower risk, in order to have the funds for those first several years of payouts. Professional trust departments are good at this; use one as the trustee! The better the investments, the more for the charity at the end.

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QUESTION:

Is it too late for a CRT to be set up after a farm sale?

ANSWER:

Yes. Assets transferred to the CRT must be unsold, with the disposition then handled by the trust. If the proper steps are not followed, the sale of the assets is taxable to the grantor of the trust.

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Editor's Note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years of experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.

Expect to retire in the next 10 years? Learn more about how to "Exit Agriculture Without Paying a Monster Tax" at a half-day DTN University workshop in Chicago Dec. 6. Go to www.dtnagsummit.com for details.

(MZT/AG)

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