Special Handling Required

Certain assets generate little or no deduction when given to charity — but may be attractive options for funding charitable remainder trusts.  For example, a farmer who contributes crops or livestock that would generally produce ordinary income if sold is limited to deducting only the adjusted basis [Code §170(e)], which may be zero after expenses have been deducted.  But if these assets are used to fund a charitable remainder trust, the farmer can avoid income and self-employment taxes on the sales proceeds (Letter Ruling 9413020).

Some deductions may be postponed until all intervening interests have expired [Code §170(a)(3)].  Funding a testamentary charitable remainder trust with tangible personal property is simple and effective, but lifetime transfers present tax challenges.  First, if the transferor or a family member (sibling, spouse, ancestor or lineal descendant) is a beneficiary of the trust, the income tax deduction with respect to the remainder interest in such property is postponed until the intervening interest of the transferor and members of the family have expired.  It’s possible that the grantor could lose an income tax deduction altogether if, for example, the grantor/beneficiary dies while the property is still owned by the trust.

However, once the property is sold by the trustee, the intervening interest ends, and the donor becomes entitled to the charitable deduction.  Where a donor funded a trust, in part, with a violin and retained the income interest, the IRS ruled that the donor no longer had an intervening interest in the tangible personal property under Code §170(a)(3) once the instrument was sold.  At that point, the donor held only “an income interest in the sale proceeds” (Letter Ruling 9452026).

The sale of the tangible personal property brings into play another charitable deduction rule — that of related use under Code §170(e)(1)(B)(i).  The deduction for an outright gift of tangible personal property is limited to the donor’s basis, rather than the property’s fair market value, if the property is not put to a use related to the charity’s exempt purposes. When the gift is in trust, the deduction is limited to the actuarial value of the remainder interest in the basis of the tangible personal property if the gift would have been unrelated to the charitable remainderman’s exempt purposes [Reg. §1.170A-4(b)(3)(i)].  The sale of personal property by a charity is generally considered an unrelated use, and the sale by the trustee of a charitable remainder trust is also an unrelated use, so the deduction must be reduced (Letter Ruling 9452026).


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