Is a charitable trust right for me? Part 3: “flip” charitable remainder unitrusts
I flip over Flip CRUTs!
I love “flip” charitable remainder unitrusts (flip CRUTs). This special type of gift planning vehicle is flexible and allows some donors to achieve their financial and philanthropic goals in a way that standard unitrusts or gift annuities cannot.
A flip CRUT is a type of charitable remainder unitrust permitted by federal tax law that meets all the requirements applicable to a standard CRUT. The difference between a standard CRUT and a flip CRUT is that until there is a triggering or “flip” event (which is written in the trust document), the payments to the income beneficiary will be the net income earned by the trust, or a payout percentage stated in the trust document, whichever is less. In the year after the triggering event occurs, the trust flips to a standard CRUT, making payments to the beneficiary based on the stated payout percentage. This percentage is multiplied by the fair market value of assets in the account each year to determine how much money the income beneficiaries receive over the next 12 months.
When is a flip CRUT useful?
One scenario in which flip CRUTs are useful is when a donor wants to fund her trust with illiquid assets, such as real estate, a business interest, or even some types of tangible personal property like valuable jewelry, a boat, and maybe even a prize racehorse. A flip CRUT allows the donor to donate an asset earning little to no current income (undeveloped real estate is a perfect example) to a unitrust, secure an immediate charitable tax deduction for a portion of the property’s value, and begin receiving a standard unitrust payout at a later date once the funding assets (the real estate) is sold and reinvested.
Here’s an example: A loyal donor wants to make a large gift to Duke, but she is uncomfortable with the idea of parting with her retirement assets. However, she does own a large piece of undeveloped property in another state. The property was left to her a long time ago by her family (probably a low basis asset) and is currently valued at $500,000 by a local appraiser. A local farmer uses the property, which generates an income of less than $10,000 per year. Meanwhile, the donor pays taxes on the property, and she is tired of worrying about it.
This property is not appropriate for a standard CRUT. Why? Because if the donor makes the real estate gift to a standard CRUT and the property fails to sell quickly, the trust cannot make the required payments to the donor. If the trust was set up to make quarterly payments to her, within the first 3 months of the trust there is a big issue – for the donor, for the organization, and especially the IRS.
On the other hand, a flip CRUT could be a great solution. To account for the possibility of the gift property not selling quickly, the trust is a net income trust until there is a triggering or “flip” event. In this case, the triggering event is the date of the sale of the property. Once the property is sold, there is an infusion of cash into the CRUT. A portion of that cash can be used to make payments owed to the donor that year; the rest would be invested to fund payments to her in the future and ultimately support her favorite charity. In the new tax year, the trust flips to become a standard CRUT.
Please note that for beneficiary payment purposes, the trust continues as a net income trust until the new tax year. In the example above, if this farm property (held inside a flip CRUT) was sold in July, the payments would continue to be net income payments until the new tax year. The rest of the money received from the sale goes into the trust immediately and is invested. In the new tax year, after the trust has flipped to become a standard CRUT, the $500,000 CRUT could distribute $25,000 that year in payments to the donor.
In this scenario, the donor receives a nice charitable deduction and a much greater cash flow, the charitable beneficiary knows that a sizable gift is in the wings, and the donor is now free from managing an out-of-state property. It’s a WIN-WIN-WIN!
Now, do you see why I flip over flip CRUTs?
For more information on flip CRUTs or any of the charitable trusts featured in this series, please contact Duke’s Office of Gift Planning.