June 16, 2017
By Mark Balzarini and Scott Miller
For years, you have been working hard to accumulate wealth in your farm operation. You have valuable equipment, and now it is coming time to retire.
What are you going to do with this equipment if there is not a child or grandchild who is going to replace you on the farm? Is there a way to sell this equipment and not incur the recapture of depreciation tax liability (taxed as ordinary income)? Is there a way to use this equipment to fund your retirement?
While you were actively farming, it is likely you fully depreciated your equipment. This means there is no cost basis remaining in this equipment. If you sell the equipment, you will recognize ordinary income on the sale. The federal and state tax on the ordinary income will range from 40% to 50%, depending on your personal income tax rate. The payment of this recapture of depreciation tax will greatly reduce the funds available for your retirement. Is there an alternative?
Charitable remainder trusts
A charitable remainder trust may be an option for you. By using a charitable remainder trust, you are able to use assets that are highly appreciated or fully depreciated while still having significant value, such as farm equipment, to create an income stream. This income from the trust can be made to you for your lifetime or for a period of years. In either case, the payout can only last up to a maximum of 20 years. If the trust is for a married couple, the income stream can be made until to the survivor’s death. However, again, the payout cannot exceed 20 years. Because of the tax savings on the sale, generally the income from the charitable trust is almost twice what the income of the proceeds of the sale would have been without the trust.
For this to work, you first transfer your farm equipment to the trustee of the charitable remainder trust. When you transfer the farm equipment to the trust, you will receive a charitable income tax deduction only for the amount of tax basis still in the equipment. This can be used to offset your personal income tax obligations. At the time of the transfer, the equipment must be free of debt. Otherwise, the amounts paid on the loan will incur an ordinary income tax liability. An option for dealing with debt on the equipment is to use other assets as collateral, such as real estate, and have the lender release the equipment from the debt. The trustee then sells the equipment without incurring any tax liability on the sale, and invests the proceeds from the sale.
CRUTs and CRATs
From these investments, the trustee makes annual payments to you. You have the option to elect to receive either a fixed percentage of the trust assets. This is called a charitable remainder unitrust (CRUT). Or, you can elect to receive a fixed amount of money. This is called a charitable remainder annuity trust (CRAT). After the payout period is up, the assets remaining in the trust are transferred to the charity of your choice.
If you use a CRUT, the amount of money you receive is based on the value of the assets held in the trust. The value of assets is determined each year prior to the payout. As the assets in the trust appreciate, the amount you receive will increase. Since the assets are able to grow inside of the charitable trust tax-free, there is an opportunity for these investments to grow very quickly.
When using a CRAT you will receive a fixed amount of money each year. This option is good if you want a steady income stream. However, you should be aware this this type of trust does not protect you from inflation — so if you are planning to receive these payments for a long period of time, a CRAT may not be the best option.
As the yearly payments come to you from the trust, you can use these however you want. These can be part of your retirement income, or these can be used to replace the property given to the charitable trust. For example, you may be able to use these payments to pay the premiums on a life insurance policy with a death benefit that replaces the value of the equipment you gave to the charity, replacing the inheritance for your heirs. When using a life insurance policy to replace assets, it may be advisable to hold the life insurance policy in an irrevocable life insurance trust to prevent the death benefit from being included in your taxable estate.
Whenever using complex plans such as those discussed here, it is advisable to consult with an attorney who specializes in estate planning.
Balzarini is an associate attorney based in Rochester, and Miller is an attorney based in Tyler for Miller Legal Strategic Planning Centers, P.A. Contact them at [email protected].
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