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.
