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FLIP
UNITRUSTS
A
Flip Charitable Remainder Unitrust provides the flexibility
necessary for some assets by combining aspects of
a net income unitrust and a regular unitrust. It is
an excellent approach for people with illiquid or
unmarketable assets to fund a trust that will make
an irrevocable commitment to their favorite charity
(or charities).
The
IRS created the Flip Unitrust in 1998. The regulations
permit the trust to function without paying any income
to the trust beneficiary (or beneficiaries). After
a predetermined event, such as the sale of the asset
funding the trust, the Flip unitrust "flips" (becomes)
a regular unitrust on the following January 1st. Since
the asset in this case has been sold, the trustee
may invest in income-producing assets for the trust
and may begin making regular income payments to the
beneficiary (ies).
 For
example, Mary Jones owned real estate that she inherited
some twenty years ago from her parents. Her cost basis
was only $10,000, but the development land had appreciated
dramatically and had a current fair market value of
$300,000. She and her advisor discussed options and
the idea of a trust that would pay her 7% each year
was very attractive to her. It also enabled her to
provide a large charitable gift for a charity that
was very meaningful to her, something she had hoped
she would be able to do.
Her
advisor helped Mary transfer the $300,000 in property
to a FLIP unitrust. The FLIP unitrust document the
advisor drew up specified that the trigger event would
be the sale of 50% or more of the property. Until
the trust had sold that property, the unitrust remained
a net income with makeup trust. Since there was no
current income from the property, the trust did not
pay any income to her.
The
property did not sell for about two years. Under the
net income rules, the proceeds of the sale were invested
and Mary began to receive the 7% income and, since
the trust was earning more than 7% on its investments,
it also made up part of the income that had not been
paid prior to the sale of the real estate. On January
1st after the trigger event, the trust "FLIPed" and
became a standard unitrust.
Over
Mary's lifetime, her advisor estimates the trust will
pay out over $440,000. Based on actuarial and income
assumptions, when she passes away, the $300,000 trust
will have grown to $420,000. Mary will receive a steady
income for her lifetime, with about two thirds of
the payouts taxed at favorable capital gain rates.
She also avoided an immediate capital gain tax of
$43,500 and perhaps saved some potential estate taxes
by removing the property from her estate. And, she
had the joy of knowing and informing her favorite
charity that a significant gift had been made that
they could look forward to.
A
flip trust provides flexibility for donors with hard
to value or illiquid assets. A flip trust can be managed
so that illiquid assets may be sold in a tax advantaged
manner, the proceeds reinvested in a balanced portfolio
and life income payments received by the donor and/or
other beneficiaries.
There
will probably be expenses associated with a trust,
especially a trust involving real estate (taxes, insurance,
maintenance for example). The donor should recognize
that prior to the trust generating income, the donor
will need to fund the expenses by making additional
gifts to the trust in anticipation of the expenses.
There
are many different types of events that can trigger
the flip. The event cannot be discretionary and must
be specified in the trust documents. Examples of some
events that could be used to trigger a flip are:
- A
single event
- Birth,
death, marriage, or divorce
- The
sale of all or a specified part of an illiquid asset
- A
person reaching a certain age
- A
specific date
Return
to Charitable Remainder Trust
story or the Real Estate
story.
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