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Tax Quote of the Week
"The most damaging thing you can do to any businessman in America is
to keep him in doubt, and to keep him guessing, on what our tax policy
is."—Lyndon B. Johnson
President Obama Outlines Health Care
Reform
As Sen. Max Baucus (D-MT) and the Senate Finance Committee continue to
labor to produce a major health care reform bill, President Obama sent a
letter to both Sen. Baucus and Sen. Edward Kennedy (D-MA).
In the letter, President Obama outlined his principal positions with
respect to health care reform. He started by noting, "health care
reform is not a luxury. It's a necessity we cannot defer. Soaring health
care costs make our current course unsustainable."
Because of the rapid increase in the costs of health care, President Obama
advocates not postponing health care reform any longer. He also believes
that a "public health insurance option" is an important part of
providing all Americans with health care.
To cover the costs of health care reform, President Obama offers three
recommendations. First, he has proposed "$635 billion in a health
reserve fund" to be funded with taxes on electricity and other energy.
Second, he lists proposals to reduce Medicare spending by $309 billion in
10 years.
Finally, he suggests that limiting itemized deduction benefits to the 28%
bracket, even though taxpayers in 2011 may be in the 39.6% bracket, would
"raise $326 billion over 10 years." This proposal would limit the
charitable and mortgage deductions of higher-income taxpayers.
Editor's Note: Senator Baucus has been meeting with other senators
from the Senate Finance Committee and the Health, Education, Labor and
Pension Committee. He plans to release the outline of his major health care
reform bill the week of June 15, 2009. The financing options for major
health care reform will prove quite controversial in the current economic
climate.
Chairman Bernanke Highlights the Need to Raise Taxes
Federal Reserve Board Chair Ben Bernanke testified before a House Committee
on June 3, 2009. He observed that the economy is stabilizing and will start
to recover by the end of this year. With reduced consumer spending and the
problems in the housing market, the recovery is anticipated to be slow.
Economic growth will be "below its longer-run potential for a
while."
Chairman Bernanke noted that the 19 largest U.S. banks had been evaluated
to determine that they held a safe level of capital reserves. The Treasury
study recommended that 10 of the 19 banks acquire a total of $75 billion in
added equity. The equity-building programs under way have already accounted
for $48 billion of the needed $75 billion in new reserves. The balance is
anticipated to be raised by November 9, 2009. The success of the banks in
raising private capital indicates that investors are "gaining greater
confidence in the banking system."
However, Chairman Bernanke noted that it is now the time to start planning
for a "restoration of fiscal balance." The national debt as a
percentage of the economy will increase from 40% of the gross domestic
product in 2008 to 70% of the economy by 2011. As a result, tax rates must
be raised to a "level sufficient to achieve an appropriate
balance" in the federal budget.
Editor's Note: Chairman Bernanke has been supportive of the
Administration's efforts to stabilize the banks and bring recovery to the
economy. These stimulus efforts led to a deficit of $1.8 trillion this year
and approximately $1 trillion next year. He now is suggesting that
regaining fiscal balance and paying down the national debt will require
substantially higher taxes in the future.
Conservation Easement Battle of the Appraisers
In Nick
R. Hughes v. Commissioner; T.C. Memo. 2009-94; No. 6395-06 (6 May
2009), the Tax Court upheld a deficiency on an overvalued conservation
easement.
Nick R. Hughes purchased two parcels of property in the Gunnison County
area of Colorado. On October 6, 1999, he purchased a parcel called the Bull
Mountain property for $1,535,000 ($787 per acre). On September 18, 2000, he
purchased an adjoining parcel named the Sylvester property for $671,350
($1,449 per acre).
On December 28, 2000, he granted a conservation easement to the Valley Land
Conservancy, a Colorado nonprofit corporation. The conservation easement
restricted construction of buildings, subdivision of the property and
commercial or industrial use of the property.
Mr. Hughes secured the services of appraiser Pamela M. Sant of Appraisal
Associates of Colorado, Inc. She appraised the two parcels together at a
combined value of $4,100,000 and determined that a 70% loss in value due to
the charitable easement produced a charitable deduction of $3,100,000. The
IRS permitted an easement deduction value of $1,992,375 and accessed a
deficiency of $437,153.
Defendant's trial expert Mark Weston noted that the $4.1 million value
would be correct based on the assumption that the property could be rezoned
and sold for residential purposes in 35-acre lots. The 70% decrease in
value is then due to the assumption that Mr. Hughes had agreed not to develop
the property for residential purposes.
IRS expert Kerry Packard opined that the Bull Mountain property had
increased in value from $1.53 million to approximately $1.7 million during
the intervening 15 months between purchase and the gift. He also observed
that because the Sylvester property had not been held for a year and
deductions under Sec. 170(e)(1)(A) are limited to cost basis for short term
capital gain assets, the Sylvester property value was deemed unchanged. Mr.
Packard also claimed that the reduction in value due to the conservation
easement was from 0% to 10%.
The Court determined that there were four potential issues. First, there
was no factual basis for the claim that the property could have been
subdivided and the 39 lots readily sold. Second, the access to the property
was still limited to agricultural and not residential purposes. Third,
there was no proof that the Bull Mountain property had been sold in a
distress sale and therefore the price was substantially depressed. Finally,
the Court determined that the 70% reduction in value for the easement was
too high, but the 10% Treasury claimed value for the conservation easement
was too low. However, due to the Sec. 170(e) loss of deduction for
appreciation that is not long-term gain, the issue was moot. The IRS
deficiency was sustained.
Applicable Federal Rate of 2.8% for June -- Rev. Rul. 2009-16; 2009-22
IRB 1 (18 May 2009)
The IRS has announced the Applicable Federal Rate (AFR) for June of 2009.
The AFR under Sec. 7520 for the month of June will be 2.8%. The rates for
May of 2.4% or April of 2.6% also may be used. The highest AFR is
beneficial for charitable deductions of remainder interests. The lowest AFR
is best for lead trusts and life estate reserved agreements. With a gift
annuity, if the annuitant desires greater tax-free payments the lowest AFR
is preferable. During 2009, pooled income funds in existence less than
three tax years must use a 4.8% deemed rate of return. Federal rates are
available by clicking
here.
In 1969, Decedent established Trust to pay a fixed annuity of
$A from the net income of Trust to five nieces and nephews
("Annuitants") and, upon the death of any of these, to their
issue. The remaining net income plus any amounts to a deceased Annuitant
not survived by issue was to be distributed among six charitable
organizations ("Charitable Remaindermen"). Upon the death of all
Annuitants and their issue, Trust was to be distributed to Charitable
Remaindermen. Because Trust had grown to nearly five times its original
value, while only a small portion of Trust would be needed to meet the
Annuitants' payments over the next forty or so years, Charitable
Remaindermen proposed modification of Trust. The proposed modification
provided for partial termination and early distribution to Charitable
Remaindermen of the Trust corpus exceeding the amount needed to meet
Annuitants' payments. Charitable Remaindermen sought a ruling that this
modification would not destroy Trust's tax-exempt status or trigger the
realization of gain or loss to any party.
The Service ruled that the partial termination and early distribution will
not destroy Trust's tax-exempt status or result in the realization of
capital gain or taxable income to any party. Sec. 2601 imposes a tax on
every generation-skipping transfer. According to Sec. 1433 of the Tax
Reform Act of 1986 and Reg. 26.2601-1(b)(4)(i) regarding
generation-skipping transfer tax (GSTT), GSTT does not apply to a trust
that was irrevocable by September 25, 1985 (unless additions to trust were
made after this date) and modification will not destroy existing tax-exempt
status. Reg. 26.2601-1(b)(4)(i)(D)(1) states that GSTT will not be imposed
so long as the modification does not shift a beneficial interest to a
lower-generation beneficiary and does not extend the time for vesting the
beneficial interests of the original trust. GSTT does not apply to Trust
because it was irrevocable on September 25, 1985 and the proposed
modification will not shift or extend the time for vesting any beneficial
interests. Annuitants will receive the same amounts for the same period of
time.
Reg. 1.1001-1(a) states that gain or loss realized from the conversion of
property to cash or the exchange of property for property differing
materially in kind or extent is treated as income or loss sustained. In Cottage
Savings Ass'n v. Comm'r, 499 U.S. 554 (1991), the U.S. Supreme Court
held that the exchange of "substantially identical" property does
not trigger realization of gain or loss. The Service interpreted this to
mean that the interests of the Annuitants and six charities in Trust will
not differ materially from the proposed partial termination of Trust and
the early distribution to Charitable Remaindermen because the legal
entitlements and payments to beneficiaries will remain the same. Although
the modification will distribute a large portion of Trust corpus to
Charitable Remaindermen early, all other Trust provisions will remain the
same with no material difference in the kind or extent of legal entitlements
and thus no gain or loss will be realized as a result of the modification.
With major changes in the stock and bond markets the past
year, some unitrust donors may prefer the simplicity and stability of a
gift annuity. The fixed payouts and knowledge that the full assets of the
issuing charity (which often are millions or tens of millions of dollars)
stand behind the gift annuity permit the donors to sleep soundly at night.
A good solution is to consider taking the income value of a unitrust or
annuity trust and exchanging that amount for a gift annuity. But what are
the rules or guidelines for a unitrust to gift annuity conversion?
In PLR 200152018, a unitrust donor was interested in rolling over the
income interest of the unitrust into a gift annuity. The donor had created
a standard 5% unitrust that made payments quarterly for his lifetime.
Apparently, a single charity was a remainder recipient and held a vested
interest.
The charity desired to use the remainder value as a current gift. While in
the past some charities have borrowed against a vested remainder interest
for a current project, the donor and charity proposed a better solution.
The donor desired to receive income and was not willing to gift the entire
income interest to the charity at present. However, if the income interest
from the 5% unitrust could be converted to a gift annuity, the donor could
receive a reasonable income stream for life and the charity could use the
remainder value immediately for a current project.
Karl Hendricks was a man with the golden touch. Throughout his
life, it seemed every investment idea that he touched turned to gold. By
far, Karl was most successful with real estate investments. It was definitely
his passion.
Amazingly, Karl continued to buy and sell real estate at the age of 85. For
instance, about three months ago, Karl discovered a great investment
property. It was a "fixer-upper" commercial building in a great
area. While other nearby buildings sold for over $2 million, the seller
needed to sell quickly and was asking just $1 million.
The condition of the building turned many buyers away. It was being sold
"as-is." But Karl was not deterred. He could see great potential
with the building and knew it would not take much to get it to market
condition. Therefore, Karl swooped in, bought the building for $1 million
and instantly hired contractors to refurbish the place.
After three months of hard work refurbishing the building, the place looked
like new! In the end, Karl invested $250,000 in the building bringing his
total investment in the property to $1.25 million. One month after the
completion of the work, the building was appraised for $2 million! This was
no surprise to Karl. He knew the building was another great buy.
Once the building was completed, Karl leased the building to a Fortune 500
company. The lease contract was for 10 years and it included an
"option to buy" provision. The lease income represented a 12%
return on investment for Karl, so naturally he was very happy with his
investment. However, after seven years, the property value grew to $3
million and Karl decided it was time to sell the property. The Fortune 500
company has not elected to exercise its option to buy during the seven year
time period.
Karl learned about the benefits of a FLIP CRUT, and he decided that looked
like the perfect solution. (See Part 1 for the benefits of a FLIP CRUT.)
Karl's attorney was very familiar with CRTs and was positive about the
proposed solution. However, Karl's attorney was concerned with one issue in
particular - prearranged sale.
If Karl transfers leased property subject to an "option to buy"
to a FLIP CRUT, will this constitute a prearranged sale? When the property
is eventually sold, will Karl avoid the capital gains on the property or
must he recognize the capital gains personally?
Note: Case studies, articles, commentary and other materials in the
GiftLaw system are included solely as educational information. Articles and
editorial comments are offered as an educational service to friends of this
organization, and may not always reflect our official position on any
issue. Since case studies or articles may not always reflect the current
AFR or tax law, it may be necessary to run any illustration with a current
version of Crescendo to obtain updated information. If professional
services are required, all persons shall consult with their qualified
professional advisors. Tax Quotes are courtesy of Jeffery L. Yablon,
Washington, D.C.
©
Copyright 1999-2009 Crescendo Interactive, Inc.
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