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Friday October 7, 2022

Case of the Week

Son's Intentions Paved with Gold -- Part 5


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 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.)

One part of the plan involved Martha's 20-acre rear parcel of land. Specifically, Martha's unitrust would receive the 20-acre rear parcel, which the university intends on eventually developing. To generate the necessary trust income, the university would purchase the land from the trust with a 7% interest-only note. After the payment of the 6% unitrust payout each year and trust expenses, the trust would accumulate any excess income.

Sam, Martha's son, is the sole owner of Bank Co. Wanting the very best for his mother, Sam wants to provide trust and banking services to Martha's unitrust. Sam knows Bank Co. would provide excellent services at very reasonable prices. Fortunately, after reviewing the applicable tax rules, Sam and Bank Co. may provide trust and banking services to Martha's unitrust without violating the self-dealing rules. (See Case Study "Son's Intentions Paved with Gold, Part 3" for a full explanation.)


With that hurdle cleared, Sam now wonders whether there are any investment restrictions or prohibitions in the tax code unique to charitable remainder trusts?


There is a prohibition on investments that jeopardize the carrying out of a foundation's charitable purpose. See Sec. 4944. If such an investment is found, then an excise tax may be imposed. This private foundation prohibition also applies, in limited cases, to charitable lead trusts. However, charitable remainder trusts are not subject to this private foundation rule. See Sec. 4947(b)(3)(B). Still, investment managers should consider their general obligations under federal and state law to act with reasonable prudence in terms of investments.

Conversely, the tax regulations on charitable remainder trusts directly prohibit certain restrictions imposed on trustees. Specifically, no restriction may be imposed on the trustee of a CRT that would prevent the trustee from realizing a reasonable amount of income or gain from the sale or disposition of trust assets. For example, a donor or trust instrument may not require a trustee to invest in only a certain type of investment. However, a non-binding investment objective may be permissible.

With limited investment provisions in the tax code, Sam and Bank Co.'s duties and responsibilities as trustee are determined largely by state law. For instance, most states have enacted some form of a prudent investor rule which governs areas such as diversification, portfolio strategy, managing risk and standard of care. Since Sam and Bank Co. are in the business of providing trust and banking services, they should, accordingly, be very familiar with these duties.

As a result of these findings, Sam and Bank Co. decide to apply the same professional management and care to Martha's unitrust as they do to all of the other trust clients.

Published October 8, 2021
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Previous Articles

Son's Intentions Paved with Gold -- Part 4

Son's Intentions Paved with Gold -- Part 3