Why Retiring Farmers Might Use a Rawhide Trust

 

“The estate tax is the government’s way of getting even for all of your income tax maneuvering”

 

One of the problems farmers, ranchers and other family business owners have with the built up tax liability that exists when owners sell out and retire is how to control the timing of tax triggers.  Why is that?  Many farm business owners look at their books annually and decide to buy feed, seed, fuel, and fertilizer before year-end to show little taxable profit.  Those years of income deferral come back to haunt farmers the last year of business with a vengeance when they close out the business.  Since everything they sell is depreciated or an ordinary income asset, it is a common trap; there is no offsetting business expense to reduce taxable income, so the last year is a bonanza for the IRS.

 

“Rawhide trusts” that make use of livestock, agricultural products, or farm equipment, may exist not to generate an income tax deduction but to defer recognition of taxable income, which may be an important part of an exit strategy for a farm business owner.

 

Internal Revenue Code §1231 defines “livestock” as including cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals.  However, poultry, chickens, turkeys, pigeons, geese, other birds, fish, frogs, reptiles, etc. are not included.  This distinction is important because “livestock” held by the taxpayer for draft, breeding, dairy, or sporting (e.g., racing) purposes may qualify for long-term capital gain treatment upon sale, exchange, or involuntary conversion.  Specifically, livestock will qualify for IRC §1231 treatment if held:

(i) for 24 months or more from the date of acquisition in the case of cattle or horses, or

(ii) for 12 months or more from the date of acquisition in the case of such other livestock.

An outright contribution of qualified “livestock” to a public charity that puts them to a related use should qualify for a fair market value deduction.  Donors must distinguish between animals purchased and those raised by the donor; the latter are going to be ordinary income assets.  The term "certain capital gain property" as used above means any capital asset which if sold on the date of contribution at its fair market value would have resulted in long-term capital gain to the donor.  While it is useful to a veterinary school or university animal science program when a donor contributes livestock or race horses that qualify for a full fair market deduction, these gifts may not be quite as suitable for transfer to a CRUT because there is no “related use” for livestock inside a charitable remainder trust.  Although, if the donor contributes tangible property (livestock, equipment, grain, etc.) as a way to avoid recognizing an immediate income tax on sale of an asset, even if it creates a tiny deduction hinged on tax basis and not fair market value, then CRT planning still may be a useful solution.  (PLR 9413020)

 

Crops

The determination of whether crops are tangible personal property or part of real estate depends on whether the crop has been harvested.  Reg. §1231-1(a) provides that “unharvested” crops sold with the land on which the corps are located (and which has been owned by the seller for more than one year) are considered long-term capital gain property.¹   It is immaterial if the length of time that the crop, as distinguished from the land, is held for more than a year.  Accordingly, for charitable deduction purposes, a contribution of land containing unharvested crops to a public charity is based on the fair market value of the land and crops on the date of contribution and is still subject to the 30% AGI deduction limitation.  The use to which the charitable organization places the crops sold as a part of the donated land is immaterial to the donor's deduction because those crops are not considered tangible personal property.  However, this income generated from the sale of crops could be considered unrelated business income under IRC §512 by the charitable organization.  Because a CRT currently has severe penalties for unrelated business income, so any land with unharvested crops may be unsuitable for transfer to a charitable remainder trust because the production of UBTI causes the trust to lose its tax-exempt status.  If a donor contributes harvested crops, a tangible personal property item, it is considered ordinary income property.  The deduction for a contribution of ordinary income property to a public charity is limited to the lesser of fair market value or cost basis, and is subject to the 50% deduction limitation even if donated for a related charitable use because unharvested crops are considered a gift of a futures contract.

 

If a farmer harvests or contributes crops, it does not cause realization of income.  However, if a property owner receives crops as apart of a sharecropping agreement, then it is ordinary income when received.  After being recognized as an ordinary income asset, if the sharecropper contributes those crops then a charitable contribution deduction for their fair market value is available.²

[1] the tax treatment for a sale that results in a net capital loss, is an ordinary loss.

[2] Thompkins v. U.S. (S.D. Ill. 1977)

 

© 2002 -- Vaughn W. Henry

Gift and Estate Planning Services

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