Saturday July 2, 2022
Case of the Week
Dealing with the Five & Dime
Case:Several years ago, Martha and Frank built a very unique home on 45 acres of beautiful rolling hills and woods. Frank passed away three years ago, and Martha now solely owns the 45-acre parcel and home.
She enjoys the peaceful country view out her front window. However, the university adjacent to the property is very interested in acquiring the property for eventual future growth. Not surprisingly, Martha is concerned. She does not want a new dormitory filled with college students in her front yard. In fact, she enjoys the peace and protection of her lovely home in the wooded countryside. However, at age 80, she recognizes that eventually some planning will have to be accomplished.
After obtaining a thorough understanding of Martha's needs and desires, Martha's attorney, Paul, crafted a wonderful four-part solution which incorporated an outright sale, a unitrust, a gift annuity and a gift of a remainder interest in a home. (See Case Study "Peace in the Countryside" for a full explanation.) This solution seemed like the perfect fit until Martha requested a special favor.
After Frank's death, Martha began making small arts and crafts to pass the time. Apparently, Martha has a real talent because friends and neighbors have been buying everything Martha creates. Seeing the joy this newfound hobby brings, Martha, with the support of her family, wants to open a small "five and dime" general store on the rear 20-acre parcel where she could sell her arts and crafts. Because the rear 20-acre parcel borders on a major country road, it would get plenty of passers-by traffic.
As one component of the four-part solution, Martha really likes the idea of putting the rear 20-acre parcel into a unitrust. Given her new business idea, she wonders if she can lease a very small portion of the rear 20-acre parcel from the unitrust. Martha would agree to any fair and reasonable lease agreement. Moreover, the university does not object to such a simple and modest use.
Question:Can Martha, the university and the trustee agree to this "five and dime" lease arrangement? Must the lease arrangement represent a fair market lease value to both parties? What are the rules governing transactions between donors and charitable remainder trusts?
Solution:Charitable remainder trusts are subject to Section 4941, which prohibits acts of self-dealing. The self-dealing rules generally state that a disqualified person cannot buy, sell, lease or otherwise transact business with the trust. This rule is designed to prevent donors from receiving benefits from their trust, other than the stated trust distributions each year. If an act of self-dealing is found, the tax code imposes an excise tax on such acts. Finally, there is no exception for economically favorable transactions to the trust. In other words, a disqualified person cannot argue "it is a really great deal for the trust."
In this case, Martha is a disqualified person with respect to the unitrust, since she is a major contributor. As a result, Martha may not lease property from her unitrust. Any lease agreements between Martha and her unitrust would clearly be an act of self-dealing. Further, this conclusion is true regardless of the price Martha would be willing to pay. There is no exception for "great deals" to the trust.
At first, Martha was very upset with this news. But, like many times in her life, when one door closes another door opens. The following day after the disappointing news, Martha learned that a nearby general store was available for lease. It was close to her home, located on a busy country road and already set up for business – a true turnkey operation. Martha was thrilled with this discovery and signed a lease agreement later that day.
Despite the potential drawbacks of the unitrust and "five and dime" plan, Martha found a win-win solution. As a result, she proceeded safely ahead with her four-part solution and her business. With her newfound liquidity, steady lifetime income, general store and beautiful hillside views, Martha finds peace in the countryside and her annual six figure income stream very agreeable.