Donor-Centered Philanthropic Solutions for Retiring Farmers and Ranchers

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2 Donor-Centered Philanthropic Solutions for Retiring Farmers and Ranchers Retiring farmers and ranchers especially those who don t have an heir who desires to take over the farm may be looking for creative solutions on how to meet their retirement needs with respect to the entire farm operation. Fortunately, many philanthropic solutions exist which can help the farmer/rancher maintain his or her income in retirement and at the same time, allow the farmer/rancher the opportunity to rid themselves of the farm operations, machinery, land, livestock, grain as well as the headaches. Two notes of caution: 1) gift planners should check their gift acceptance policies for guidelines on accepting the types of assets discussed in this presentation including land, residences, farm machinery, crops, livestock, and gas/oil interests. 2) the presentation covers retiring farmers and ranchers operating their farm or ranch as a sole proprietorship (i.e., IRS Form 1040 Schedule F farmers) not corporate farms, S-corps, etc., or those engaged in share cropping activities. I. Farmland - If the farmer/rancher no longer wishes to own the farmland once retirement commences, there are many options for its disposal. If the farmer has a neighboring farmer who would like to purchase the land to increase his or her share of land ownership, a sale could be an ideal situation subject of course to any possible capital gains taxes, however. Or, if the farmer has heirs who wish to purchase the farmland, a sale/gift could be another possible solution. However, often times the heirs are living in other states and pursuing other careers than farming or agriculture. In these situations, a philanthropic option may be the perfect solution. A. Outright/major gift - If the farmer has high philanthropic intent, it may be beneficial for the farmer to give the farmland outright to charity. This would enable the farmer to have a charitable income tax deduction for the full fair market value of the land if it has been owned for more than one year. The farmer would need a qualified appraisal for the value of the land to deduct its value on his or her income tax return. The fair market value of the land today over its cost basis is long term capital gain and the tax on that amount is avoided with an outright charitable gift. Example - Farmer Fred has 400 acres of farmland worth $10,000 per acre for a fair market value today of $4,000,000. If Fred originally purchased the land for $4,000 per acre 20 years ago, his cost basis is $1,600,000 and he has long term capital gain income -if he sells it equal to $2,400,000. If Fred makes an outright gift of the entire 400 acres directly to a public charity, he National Conference on Philanthropic Planning 2015 Johni Hays, 1

3 will be entitled to a charitable income tax deduction of $4,000,000 and will avoid any long-term capital gain tax on the $2,400,000 of long-term capital gain. Fred can use the deduction in the year of the gift (up to 30% of his AGI) and for up to five years following the year of the gift. Certainly the entire farm would not have to be given to charity. Fred could instead give, for example, 200 acres of land to the charity and then sell the other 200 acres outright to another farmer. This would give him some up-front cash ($2,000,000 before taxes and expenses) and an income tax charitable deduction of $2,000,000, that can help offset some of the long term capital gain income on the sale portion. Note that any gift of real estate entails a high level of due diligence and environmental review on the part of the nonprofit: Is the property marketable? Is there a mortgage? (mortgage free land is preferable) Is it property the charity wants to keep and use? If not, the nonprofit will analyze the costs of selling. What could it sell for price-wise? Is there an up-to-date appraisal? The nonprofit will need farm/property management until it can sell the land B. Charitable remainder unitrust - If the farmer/rancher would like to continue to receive income from the farmland through his or her retirement years, an outright gift may not meet the farmer s needs. One of the life income gifts to consider is a charitable remainder trust (CRT). A gift of the farmland into a charitable remainder trust can be an ideal philanthropic solution. The farmer would work with her or her attorney to draft the particular type of charitable remainder trust, then his/her attorney would draft a deed transferring the ownership of the land into the charitable remainder trust. The trustee of the CRT would make payments to the farmer (and even the spouse if specified) for the duration as stated in the CRT (e.g., one life, two lives, or a period of time up to 20 years). Upon the termination of the income interest, the balance of the assets inside the CRT is transferred to the charities that the donor specified in the trust agreement. Donor story: farmland - Farmer Fred is single and 72 years old. He has the same 400 acres of land from above. He worked with his local attorney to draft a FLIP CRUT that will pay Fred 5% of the annual trust balance per year for the remainder of Fred s life. After Fred s death, the balance in the trust will be transferred 50% each to his two favorite nonprofits he named in the trust agreement. Because it is a FLIP CRUT, Fred was able to choose the triggering date. He chose the trigger to be the sale of the farmland. Therefore, Fred will start receiving 5% beginning January 1 of the year following the year in which the trustee sells the farmland. Up until that National Conference on Philanthropic Planning 2015 Johni Hays, 2

4 time, the trust acts as a NIMCRUT and will provide him with the lesser of the actual trust income earned or the 5% as stated in the trust agreement. Fred s federal charitable income tax deduction assuming a 2.2% IRC 7520 rate is $2,215,920. Avoid a CRAT - The CRT payments to Fred will be taxed to him under the 4-tier taxation system for CRT distributions under IRC 664. Note that his CRT will make variable payments for life as the CRUT pays 5% based on an annual valuation of the trust assets. Let s say Fred is uncomfortable with the idea of a trust that pays a variable payment amount each year, and so he doesn t want to use a CRUT. Instead Fred wants a fixed payment amount year after year. Would a charitable remainder annuity trust (CRAT) be an ideal solution for Fred? Not really. Using a charitable remainder annuity trust which pays a fixed amount can be a disastrous solution. Why? Since it only allows one contribution into the trust, if the land cannot be sold before the trustee must begin making payments to the income beneficiaries, a CRAT can be left with little to no liquidity to make the payments to the income beneficiary depending on the amount of income, if any, the land is earning. The donor cannot make an additional contribution of cash in the interim period to help with the cash flow problem. Therefore, a CRAT is typically not recommended for a gift of land. However, if Fred has his heart set on fixed payments for life, he may have better luck opting for a charitable gift annuity. C. Charitable gift annuity - A charitable gift annuity pays fixed payments for life, so accepting a farm in exchange for a CGA from a retiring farmer or rancher can be an ideal solution. However, the nonprofit must note that accepting farmland for an immediate payment CGA has much higher risk to the charity than accepting liquid assets. One risk is that the nonprofit will receive less for the farmland once it is sold than it was worth when the CGA was established. For example, if the CGA contract is written in September 2015 when 400 acres of land is worth $10,000 per acre ($4,000,000) and then it takes 15 months for the land to sell at $9,500 per acre then after expenses the charity nets $3,800,000 yet the charity has signed a CGA contract to pay the CGA rate on $4,000,000. The main concern, therefore, is how much the charity can sell the farmland for and equally as important is how quickly it can be sold. Obviously, the charity will need to perform the normal amount of due diligence on the farmland BEFORE accepting it: examining the property (both physically and legally), any zoning issues and environmental checks just to name a few. Plus, your organization will need to have another source of liquid funds to make the gift annuity payments before you sell the farm. Check with your organization is that a deal breaker? National Conference on Philanthropic Planning 2015 Johni Hays, 3

5 The charitable gift annuity is not designed to allow an organization to accept real estate for a CGA and delay making CGA payments until the charity sells the land. The charity can do a deferred CGA until a certain date, but not a date dependent upon when the land sells. In that scenario, a FLIP CRUT may make more sense, but the payments will be variable in amount. Should the nonprofit adjust the land s value to reduce its risk? - Let s say your boss agrees to accept the real estate but at a value less than your institution s appraisal shows. Should you arbitrarily establish a lower value of the land to reduce your institution s risk that the land will not be sold for some time, or that it will bring a value much lower than the current appraisal states? In other words, if the donor s appraisal states the real estate is worth $1,000,000, should you agree to do a gift annuity based on the land being worth $850,000? To cover your risk, negotiate a lower gift annuity rate with the donor (subject of course to any state law restrictions against it). So, if the normal rate for the donor/annuitant is 7.3%, you instead could negotiate a rate of say 6.5%, assuming your donor agrees to it. State law issues - Check to see if there are any state law restrictions against accepting real estate in exchange for a CGA. You ll also want to be sure that if the particular state required your institution to submit or disclose its CGA rate schedule, that you have the ability to offer a gift annuity rate lower than what s on the schedule. Donor story #2: farmland - Farmer Fred had never been a donor to this charity before he at the age of 72 gave a charity one-half of his $4,000,000 farm in exchange for a CGA. In other words, of his 400 total acres, he gave charity 200 acres. Fred sold the remaining 200 acres to his neighbor because Fred never had any extra cash around and wanted to have a little cash on hand. Fred s cost basis in the 200 acres for the CGA is $4,000 per acre. His CGA rate is 5.4% ($108,000). He avoids paying immediate capital gains income tax on the difference between $10,000 per acre and his cost of $4,000 per acre on ½ of the farm. However, the capital gain will be spread ratably over Fred s lifetime because he is the owner of the property and is the annuitant. In this case, the long-term capital gain of $1,200,000 is reported over 15.5 years, the expected lifetime of the donor/annuitant. Fred also has long-term capital gain income on the other ½ of the farm he sold to a neighbor. $10,000 - $4,000 x 200 acres = $1,200,000 of long term capital gain income. Assuming an IRC National Conference on Philanthropic Planning 2015 Johni Hays, 4

6 7520 rate of 2.2% and quarterly payments, Fred s federal charitable income tax deduction will be $830,187 and is deductible up to 30% of his Adjusted Gross Income (AGI) with a 5 year carryforward. This deduction helps offset the capital gain income from the sale of the farmland. The end of Fred s story - Fred had very bad arthritis. So after he retired from farming, he moved to Arizona to get away from Midwest winters. About a year after Fred completed the CGA, he came back to the nonprofit and told them he d changed his will and left his entire estate to them. D. What doesn t work well for a farmer/rancher who wants to rid him/herself of the farmland? Another option is for the farmland itself to be put in a retained life estate with a public charity as the remainder beneficiary. This would entail the farmer giving a deed to the charity for the farmland while reserving the right to use the farmland for his or her lifetime. Although this option does not appear to be ideal for a farmer wanting to retire and rid himself/herself of the farmland and its responsibility, because he would still be responsible for the land -- nonetheless, this option is available. The farmer/rancher could rent the land to a tenant farmer in this case. As with the retained life estate for the farmland, a bequest of the farmland to the charity is not mentioned because it would not meet the goals of a retiring farmer or rancher who wishes to rid himself of the land during his or her retirement years. II. III. Farm house - If Fred doesn t want to live on the farm homestead anymore, and instead wants to move to town to be closer to the grandchildren, Fred may have the option to sell his home outright separately from the farmland, or do a bargain sale with the nonprofit. If on the other hand, Fred would like to continue living in the farm house for the remainder of his life, he could do a life estate and give the charity the remainder interest. A $150,000 house/land could provide Fred with an income tax charitable deduction of more than $98,000 again with a 5 year carryforward. For each gift of a remainder interest, the charity and donor need to execute an agreement stating the donor is responsible for insurance, maintenance and taxes on the property going forward. Harvested crops - A retiring farmer/rancher may often have the desire to reduce their current taxable income, yet in the year of retirement they may often have a crop to dispose of. A charitable gift of the grain can help the farmer get rid of the grain without adding its value to the farmer s taxable income. National Conference on Philanthropic Planning 2015 Johni Hays, 5

7 Outright/major gift - Harvested crops produced for sale in a farming operation are considered ordinary income property. The charitable deduction for a gift of ordinary income property to charity is limited to the lesser of: 1) fair market value, or 2) cost basis. See 1.170A-1(c)(4) Example 5. In addition, the deduction is subject to the 50% deduction limitation regardless of whether or not the crops are for a related or an unrelated use by the charity. What are the tax and other benefits to the farmer? By giving harvested grain to a charity, the farmer avoids including the sale of the grain in the farmer s taxable income. The income tax charitable deduction is typically very close to $0 for the grain because the farmer can deduct the cost of growing the crops. Note that the true benefit to the farmer is indeed the avoidance of declaring the value of the grain as income. By not having to include the value of the gifted grain into income, this results in saving selfemployment tax, federal income tax and state income tax. Example - Tax year with a gift of grain $350,000 other income from farming operations + $0 no additional income from the gift of the grain $350,000 total income The farmer pays self-employment, federal income and state income taxes based on $350,000 (less exemptions, deductions, etc.) The process must be handled very carefully in order for the farmer/rancher to avoid declaring the value of the grain as income: The farmer must deliver the grain to the elevator, then document the grain gift in the name of the charity. The charity then orders the grain sold by the elevator and the proceeds are kept by the charity. If the donor delivers the grain to the elevator, however, then sells it and orders the proceeds from the sale of the grain sent to the charity, the farmer WON T have the same tax benefits. Also, it is important to avoid making a gift of the warehouse receipt in the farmer s name. It needs to be a gift of the actual grain, not a gift of the receipt. National Conference on Philanthropic Planning 2015 Johni Hays, 6

8 If grain is given to a charitable remainder trust, the deduction if any will be delayed until the asset is sold by the trustee. Note: If harvested crops are given to charity by a non-farmer, the grain is considered tangible personal property and subject to the related use rules. Un-harvested crops are not considered tangible personal property. Therefore no related use rule applies to a gift of un-harvested crops. Un-harvested crops sold along with the land they are on are long term capital gain property. The holding period of the land (not the crops) is determinative. When the charity sells the crops once they are harvested, the income from the crops may cause UBTI. Donor story: harvested crops - Martha*, 81, was a widow and owned a farm. She was looking for more income in her retirement years, but wasn t entirely sure she d really need the extra retirement income. Her two adult children were not interested in taking over the farm. She d been giving to The Nature Conservancy for 24 years. She planned to retire and close the family farm by leasing the land to someone outside the family and selling the farm machinery. The Nature Conservancy gave her several scenarios to consider for the grain: a. A FLIP CRT funded with soybeans with CRT payments beginning upon a triggering event. Martha could also give cash to the unitrust to cover the costs incurred for transporting the soybeans. b. A charitable gift annuity was proposed with either immediate or deferred payments. c. An outright gift of the grain although she knew there would be no income tax deduction available for an outright gift of grain/soybeans. That year she harvested 16,000 bushels of soybeans at approximately $12.50 per bushel. Martha ultimately chose a deferred CGA with payments beginning one year after the transfer of soybeans which gave her a 7.4% rate on more than $200,000 worth of soybeans for life even without a charitable income tax deduction. *The donor s name has been changed to protect the identity of the donor. The above example provided courtesy of Greg Starkey, The Nature Conservancy. National Conference on Philanthropic Planning 2015 Johni Hays, 7

9 IV. Farm machinery and equipment - A farmer/rancher typically will also own large pieces of equipment along with the farmland. Some of these pieces can be worth hundreds of thousands of dollars although they may already have been fully depreciated. In these instances, several philanthropic options can help the farmer rid him/herself of the major pieces of farm machinery. Outright gift or charitable remainder trust Many times combines and other large pieces of machinery have been fully depreciated by the time the farmer retires. Therefore, an outright gift of these types of assets might produce a $0 federal income tax charitable deduction if given to charity. However, a charitable remainder trust can provide the farmer with lifetime income even with little to no charitable deduction. If farm machinery is given to a charitable remainder trust, the deduction if any will be delayed until the asset is sold by the trustee. Example - Farmer Fred has a $400,000 combine that he won t need any more in retirement. He is giving his farmland to charity so he won t need to use the combine. Further, his neighbor who farms has his own combine so he doesn t wish to purchase Fred s. Instead Fred places his $400,000 combine into a FLIP CRUT. The triggering date is the sale of the combine and Fred s income will start (5%) on January 1 following the year in which the trustee sells the combine. Since Farmer Fred already full depreciated the combine on his schedule F as a sole proprietor farmer, Fred is not eligible for an income tax charitable deduction for his combine gift to the CRT. However, Fred is fine with that because he fully depreciated it already. His main goal is the ability to receive a lifetime income from the CRT. Donor story: farm machinery and crops - A farmer and his wife farmed for many years, operating as a sole proprietorship. The couple, age 67 and 66, was determined to retire from farming. They had no children who would take over the farming operation. They planned to retire in 2011, but he had 80,000 bushels of corn (FMV $432,000) and 25,000 bushels of soybeans (FMV $293,750) to liquidate in He planned to liquidate all of his machinery (FMV $467,700) in The couple intended that the proceeds from those sales would help provide income during retirement. The couple also wanted to make a gift upon their deaths to a local charity who had been an influence in their lives. National Conference on Philanthropic Planning 2015 Johni Hays, 8

10 The husband had previously depreciated the crops and equipment so that his income tax basis in them was very small. As a result, he learned that if he sold the crops and machinery he would have depreciation recapture on them and roughly one-third of the proceeds would be paid as taxes, leaving them less available income for retirement. The charity suggested that the farmer and his wife consider a charitable remainder unitrust. They knew the gifts to the CRUT would not yield an income tax deduction. The farmer created one CRUT in 2010 for the stored grain and a second one in 2011 for the machinery. In both he named himself and then his wife as the noncharitable beneficiaries. He contributed the stored grain to the CRUT by an assignment gift document that documented the transfer and allowed the trustee to sell the grain during the year and arrange for its removal. He also did an assignment gift document for the machinery transfer which allowed the trustee to conduct an auction of the machinery during that year on the grounds of the farmer s farm. It was suggested that only one sale of the grain take place and only one machinery auction take place both advisories to avoid the trust s activity being characterized as an unrelated business activity that would yield tax to the trust. He also contributed enough cash in each trust to allow the trust to pay for the carrying costs including insurance, transport and related expenses. Both trusts were 6% Flip-CRUTs with triggering dates of December 31, 2010 and 2011, respectively. The above example provided courtesy of Sheryl Morrison, JD, Gray Plant Mooty Law Firm, Minneapolis, Minnesota. V. Livestock - In the year the farmer/rancher retires, dilemmas can occur as to what to do with the livestock whether it be cattle or pigs or other forms of livestock. Livestock includes cattle, hogs, horses, sheep, goats, etc. But it does not include poultry, chickens, turkeys, fish, etc. IRC Section 1231 defines livestock. Livestock is typically considered inventory for a farmer/rancher. As an ordinary income asset, livestock is usually deductible at cost basis up to 50% of AGI. Livestock can be given outright to National Conference on Philanthropic Planning 2015 Johni Hays, 9

11 charity upon retirement, or placed into a charitable remainder trust just like the machinery and grain. The trustee will sell the livestock and provide the donor with lifetime payments. If livestock is given to a charitable remainder trust, the deduction if any will be delayed until the asset is sold by the trustee. If a charitable remainder trust is under consideration for both land and machinery/crops/livestock, it is typically considered good practice to have a separate trust for the land as it is a long-term capital gain asset and a second trust for the livestock/grain/machinery as it can provide more favorable tax treatment of the payments to the donor. VI. Gas and oil interests - In situations where farmers and ranchers have oil and gas interests on their property, there may be a philanthropic solution for these interests. Although they can be rather complex in their design, gifts of these interests are becoming more and more common as some people owning these interests are finding new wealth and are looking for ways to use their wealth philanthropically. To begin, it is important to know if your donor owns the land (surface) and the minerals, or just the mineral interests? A. Forms of interests - determine what kind of oil and gas interest the potential donor owns. This makes a difference as to the tax nature and the ability to make a gift of that interest or not. They are generally in one of two types of interests: Working interest includes the right of the owner to participate in the production of minerals; the owner must pay for the operational costs; does not qualify as a passive investment and thus will generally trigger UBTI. Royalty interest includes the right to receive payments from the production of minerals; considered a passive investment; generally will not trigger UBTI. B. Deduction - The charitable deduction will be equal to the fair market value if contributing a mineral interest or a working interest owned for more than one year given to a public charity. If the cost basis is greater than the fair market value, then the deduction is equal to the fair market value. Moreover, the charitable deduction will be limited to the donor s cost basis if the donor is contributing a mineral interest or working interest that he or she has owned less than one year to any type of charity. National Conference on Philanthropic Planning Johni Hays,

12 If the donor wants to give the land to charity but retain the minerals, no deduction is available unless the mineral interest is insubstantial. See Rev. Rul ; CB52; Star v. Comm s, 86TC 243 (1986). Conversely, a person - who owns the surface (i.e., the land itself) and owns the oil/gas/minerals under the surface - cannot make a deductible gift of just the oil/gas/minerals because of the rules regarding gifts of a partial interest. See Reg A-7(a)(2)(i). Neither an overriding royalty interest carved out of a working interest nor a net profits interest carved out of a working interest are deductible under the partial interest rule. C. Life income vehicles - A charitable gift annuity is generally not recommended in exchange for an oil or gas interest as it can be hard for the charity to make the gift annuity payments if the interest depletes itself over time. If the gift is a working interest, the charity must consider the UBTI implications. If the mineral interest is producing revenue, the charity could use the revenue to help make the gift annuity payments. For example, a husband and wife could give their producing royalty interest worth $100,000 to a charity in exchange for a CGA. The charity can use the royalty interest payments to help it make the gift annuity payments back to the donors. A donor owning a royalty interest can give it to a CRT. Often a NICRUT is the recommended type of CRT as the vehicle. Note that a working interest into a CRT would trigger UBTI. The above gas and oil information provided courtesy of Joseph E. Hancock, JD, MBA, Trust Counsel for Baptist Foundation of Texas. VII. Summary - A retiring farmer or rancher who wishes to rid himself/herself of the responsibilities of the farm or ranch while at the same time make charitable contributions has many options to explore. Gifts can be made of the grain, farm machinery, and livestock into charitable remainder trusts to provide the farmer/rancher with lifetime income albeit without much of an income tax charitable deduction. Further, the farnland can be placed in a charitable remainder trust (preferably a FLIP CRUT) or charitable gift annuity to provide additional income. And for the retiree who wishes to remain on the homestead, a retained life estate can provide an excellent solution as well as a charitable income tax deduction. National Conference on Philanthropic Planning Johni Hays,

13 Johni Hays, JD Senior Vice President Thompson & Associates 7308 Eagle Pointe Drive Johnston, IA Phone: (515) Fax: (515) National Conference on Philanthropic Planning Johni Hays,

14 Donor-Centered Philanthropic Solutions for Retiring Farmers and Ranchers Johni Hays, J.D. Senior Vice President Analysis of Proposed Gift 1. Identity of the donor/who owns the asset? Retiring - sole proprietor farmer or rancher filing IRS Schedule F. No on-farm heirs willing to take over the farm 2. What is the asset is under consideration and the issues that asset entails? -- Farmland -- Farm house -- Grain -- Machinery -- Livestock -- Oil & gas 3. What gift technique is being considered and if there are any restrictions? Outright gift, charitable gift annuity, etc. 4. What type of charity will be the recipient and what issues does that create? Public charity status Farm or Ranch Land - Possible Options Assume a retiring farmer wanting to rid him/herself of the farm and its operations: 1. Neighboring farmer could purchase 2. Gift or sale to on-farm heir 3. Philanthropic options. 1

15 Farm or Ranch Land - Possible Philanthropic Options 1. Outright gift 2. Bargain sale 3. Charitable remainder trust 4. Charitable gift annuity Farmland - Outright Gift 1. Farmer gets out from under management headaches 2. Not becoming bogged down in complicated trusts or contract agreement as with other gifts 3. But loses control, ownership and income 2

16 Farmland - Outright Gift For long term capital gain property (held for more than 1 year), the donor s deduction = fair market value (not the cost basis) No loans/mortgage is preferable Avoids (maximum) 20% long-term capital gains tax on growth Gifts of Farmland - Example Fair market value of 400 acres at $10,000 per acre = $4,000,000 Cost basis is $4,000 per acre = $1,600,000 in 95 Gift to charity: deduct $4,000,000 up to 30% of donor s AGI; plus 5 year carryforward Avoid 20% (max) long-term capital gains tax on the $2,400,000 growth Farmland Bargain Sale A sale to a charity below the land s fair market value Difference between sale price and fair market value = charitable deduction Good when farmer has immediate larage cash needs and wants to hand over management of farm and has use for some level of income tax deduction 3

17 Farmland Bargain Sale Example Farmer Fred age 72; farmland FMV = $4,000,000; CB = $1,600,000 Farmer sells land now to charity for an agreed upon price of $2,500,000 Charitable income tax deduction of $1,500,000 up to 30% of AGI with a 5 year carryforward AND farmer has long-term capital gains tax of $300,000 (assuming a 20% rate) for the amount of gain on the sale portion of the gift Farmland - CRT CRUT provides lifetime (variable) income to farmer and spouse Farmer gives land to Trustee of CRT Farmer eligible for partial income tax deduction = present value of remainder interest Trustee sells land and uses proceeds to invest and provide lifetime income to farmer and spouse After their lifetimes, remainder is paid to charities that donor selected 4

18 Farmland - CRT Donor can retain the right to change charities during his/her lifetime Income must be at least 5% annually FLIPCRUT is preferred type of CRT for hard to sell assets Avoid using a CRAT for hard to sell assets Farmland - CRT Example Farmer Fred age 72 Farmland FMV $4,00,000; CB $1,600,000 5% FLIP CRT pays January 1 following year farmland sells inside the CRT Charitable income tax deduction of $2,215,920 up to 30% of AGI with a 5 year carryforward assuming a 2.2% IRC Section 7520 rate Avoid Property with an existing agreement to sell already in place See line of cases: Palmer and Blake cases or article on Planned Giving Design Center ( How Far is Too Far? By Emanuel J. Kallina, II, Esq. and Philip Temple, Esq. 5

19 Farmland - Charitable Gift Annuity Charitable gift annuity is a direct gift to one particular charity in exchange for FIXED lifetime payments typically to the donor (and 1 other person if desired) Farmer gives land to charity Farmer eligible for partial income tax deduction = present value of the remainder interest Farmland - Charitable Gift Annuity Charity provides lifetime payments to farmer (and possibly spouse) based on their ages at time of initial gift After their lifetimes, remaining amount is useable by that particular charity for their mission Farmland - Charitable Gift Annuity Risks increase to the charity by accepting hard to sell assets in exchange for a CGA Price Timing Ways to minimize the risk to the nonprofit 6

20 ACGA Maximum Suggested Charitable Gift Annuity Rates Effective January 1, 2012 AGE* RATE % % % % % % 90 or older 9.0% *Age nearest birthday Farmland - CGA Example Farmer Fred age 72; farmland FMV $4,000,000; farmland CB $1,600,000 Fred gives ½ of the farmland ($2 M) in exchange for a CGA and he sells the other ½ ($2M) to a neighboring farmer 7

21 Farmland - CGA Example CGA rate is 5.4 Charitable income tax deduction of $830,187 up to 30% of AGI with a 5 year carryforward Helps when he had $1,200,000 of long term capital gain on the ½ he sold to the neighbor Farmland - CGA Example Charitable gift annuity pays $108,000 every year for as long as he is alive Tax free portion of payment $ 32,270 Long-term capital gain $ 48,406 Ordinary income portion $ 27,324 Total payment $108,000 Farmland - CGA Example Now for the rest of the story.one year later 8

22 The Charity s Perspective 1. Importance of nonprofit s gift-acceptance policy 2. Real estate is full of due diligence by the nonprofit 3. Board approval is important 4. Nonprofit will analyze the costs of selling 5. Is the property marketable? What could it sell for? 6. Is there a mortgage? 7. Is it land the charity wants to keep and use? Does the donor want to restrict the charity s use? 8. Is there an up-to-date appraisal? 9. Carrying costs to the nonprofit (short and long-term) Insurance, maintenance and property management Farm House If Farmer Fred does NOT want to live in the farm house any more.. He could sell it on the real estate market, or give it outright, or do a bargain sale with the nonprofit..or.. Farm House - Possible Philanthropic Options If he wants to remain living in the farm house consider a retained life estate 9

23 Retained Life Estate Allows farmer to make a gift today; yet retain possession and use of house for life After farmer s lifetime, the charity has possession Farmer receives a partial income tax deduction in year of original gift = present value of remainder interest Retained Life Estate Farmer can keep any income the farmhouse might generate although unlikely Farmer gives home to charity via a deed but retains life estate; farmer continues to pay: -maintenance, -insurance and -taxes throughout his/her lifetime (need separate written agreement) 10

24 Retained Life Estate Example Farmer Fred age 72; house FMV $150,000 Fred gives deed to home now and retains a life estate Charitable income tax deduction of more than $98,000 up to 30% of AGI with a 5 year carryforward Charitable Gifts of Grain Grain - Possible Philanthropic Options Harvested crops 1. Outright gift 2. Charitable remainder trust 3. Charitable gift annuity 11

25 The Tax Rules Crops produced for sale in a farming operation are considered ordinary income property. The charitable deduction for a gift of ordinary income property to charity is limited to the lesser of: 1) fair market value, or 2) cost basis. See 1.170A-1(c)(4) Example 5 The Tax Rules In addition, the deduction is subject to the 50% deduction limitation regardless of whether or not the crops are for a related or an unrelated use by the charity. Outright Gifts of Grain By giving grain to a charity, the farmer avoids including the sale of the grain in income. Note, the charitable deduction is nearly $0 for the grain the benefit is the avoidance of declaring it as income. And, the farmer deducts the cost of growing the crops which results in saving self-employment tax, federal income tax and state income tax. 12

26 Example of Gift of Grain Tax Year without charitable gift of grain: $350,000 Other income from farming +$100,000 Income from grain sale = $450,000 Total income Farmer pays employment, federal income and state income taxes based on AGI of $450,000 (less exemptions, deductions, etc.) Example of Gift of Grain Tax Year with charitable gift of grain: $350,000 Other income from farming + 0 No additional income from grain gift = $350,000 Total income Farmer pays employment, federal income and state income taxes based on AGI of $350,000 (less exemptions, deductions, etc.) The Process to Complete the Gift 1. Let the charity know of the gift. 2. The charity will set up an account at the elevator. 3. Donor will deliver the grain to the elevator or co-op. 4. The donor will have the elevator transfer the grain to the charity via step #5. 13

27 The Process to Complete the Gift 5. Have the elevator send a warehouse storage receipt to the charity the receipt must show the charity as the owner of the grain. 6. The charity will give the donor a donation receipt for the gift but it is basically nondeductible. 7. The charity will sell the grain and receive the sale proceeds. Tips to Consider After the gift, the charity is responsible for storing and or transporting the grain, and for the risk of loss. The farmer cannot control where/when the charity sells the grain. Tips to Consider THIS IS CRITICAL: If the donor delivers the grain, then sells it and orders the proceeds from the sale of the grain be sent to the charity, the donor won t have the same tax benefits. Also, avoid making a gift of the warehouse receipt in the farmer s name. It needs to be a gift of the grain, not the receipt. 14

28 Questions and Answers Q: Can a crop sharing arrangement benefit from a gift of grain? A: No, shares of crop are rental income and must be reported as income. Q: Can a farmer store the grain on the farm and not deliver it to an elevator? A: Yes, prepare a notarized letter of transfer to the charity in place of the warehouse receipt. Questions and Answers Q: Can farm corporations benefit in the same way as the sole proprietor? A: The benefits described in the grain section of this presentation are for calendar year-cash basis sole proprietorships. Questions and Answers Q: Will the gifted grain count as income in government payments limitation caps? A: No, the gift of grain won t count as income in the farmer s government payments limitation caps calculation. 15

29 The Tax Rules Side note: If harvested crops are given to charity by a non-farmer, the grain is considered tangible personal property and subject to the related use rules. Grain - Example Martha was 81 years old; widow Owned a farm Her two adult children weren t interested in farming Planned to retire and close out the farm by leasing the farm land to another farmer Grain - Example Martha had 3 philanthropic options: FLIP CRUT CGA Outright gift 16

30 Grain - Example Martha chose a deferred payment CGA with payments beginning in one year: CGA rate 7.4% for her life More than $200,000 in soybeans Little to no charitable income tax deduction however Donor story courtesy of Greg Sharkey, The Nature Conservancy. See PGToday Dec Charitable Gifts of Farm Machinery Machinery possible philanthropic options 1. Outright gift Likely no income tax deduction 2. FLIP Charitable remainder trust likely no current income tax deduction; yet can provide retirement income; avoid CRAT 3. Charitable gift annuity likely no current income tax deduction; yet can provide retirement income 17

31 Machinery possible philanthropic options Machinery is often fully depreciated by the time of retirement Benefit of a life income gift is truly the ability to obtain lifetime payments even though the deduction will be small or nothing at all Machinery Example Farmer Fred has a $400,000 combine he has already fully depreciated it on his taxes Neighboring farmer isn t interested in buying Fred s combine; he has his own Fred uses a FLIP CRUT for the combine Machinery Example 5% payout beginning January 1 of the year following the year the trustee sells the combine No charitable income tax deduction available to Fred 18

32 Machinery & Grain Example Farmer and wife (age 67 and 66) retiring from farming in the Midwest in 2010 No children who would take over farming operations 80,000 bushes of corn FMV $432,000 25,000 bushes of soy beans FMV $293,750 Farm machinery FMV $467,700 Machinery and Grain Example Previously depreciated the crops and the machinery He learned if he sells the crops and machinery he would have depreciation recapture They instead used two charitable remainder trusts Machinery and Grain Example One trust for the grain in 2010 and a separate trust for the machinery in 2011 and transfer assets via an assignment gift document. Farmer contributed extra cash to each trust to cover carrying costs including insurance, transport and related expenses. Both trusts were 6% FLIP CRUTs with triggering dates of 12/31 each respective year. Donor story courtesy of Sheryl Morrison, Gray Plant Mooty Law Firm 19

33 Charitable Gifts of Livestock Livestock Livestock: cattle, hogs, horses, sheep, goats Does not include poultry, chickens, turkeys, fish IRC Section 1231 defines livestock Livestock 20

34 Not Livestock Livestock Considered inventory for a farmer/rancher and an ordinary income asset; deductible at cost basis up to 50% of AGI Livestock - Possible Philanthropic Options 1. Outright gift 2. Charitable remainder trust deduction may be delayed until livestock is sold inside the trust 21

35 Gas and Oil Interests Forms of interests: Working interest participates in the ownership Royalty interest right to receive payments Gas and Oil Interests Can t deduct if you give land but retain the minerals Can t deduct if you give the oil/gas interest and keep the land Gas and Oil Interests - Possible Philanthropic Options 1. Outright gift deduct lesser of CB or FMV if owned for more than 1 year 2. Charitable remainder trust NICRUT often used 3. Charitable gift annuity hard for charity to value the gift so often not recommended with depleting mineral type interests 22

36 Additional Information Crescendo s Free Webinar: How to Offer and Accept Gifts of Mineral Interests Additional Information Roger Ellingson s upcoming Planned Giving Today article on landowners giving wind rights. Questions? Johni Hays, J.D. Senior Vice President johni@ceplan.com 23