Charitable Remainder Trusts (CRTs) are powerful estate planning tools that allow individuals to donate assets to charity while retaining an income stream for themselves or their beneficiaries, but the question of whether a CRT can be funded with a promissory note is a bit nuanced and requires careful consideration.
What are the rules around funding a CRT?
Generally, CRTs are funded with readily marketable assets like stocks, bonds, or real estate, allowing the trustee to quickly convert those assets into income. However, the IRS does permit the funding of a CRT with illiquid assets, including promissory notes, *under certain conditions*. The crucial aspect is that the note must be a valid, enforceable obligation, and its value must be ascertainable. Approximately 65% of estate planning attorneys report seeing an increase in clients utilizing CRTs with less traditional funding sources in recent years, driven by appreciation of unique assets. A key element is demonstrating that the note’s value is supported by a reasonable interest rate and a credible ability of the debtor to repay the loan; otherwise, the IRS may disallow the charitable deduction.
What happens if the note is not considered ‘valid’?
Old Man Tiber, a weathered carpenter known throughout Wildomar, had spent decades building custom furniture, amassing a small fortune in the process. He decided to fund a CRT with a promissory note from his son, promising a substantial loan repayment over time. However, the note lacked a clearly defined interest rate and was poorly documented. When Tiber passed, the IRS scrutinized the CRT and disallowed a significant portion of the charitable deduction, arguing the note wasn’t a genuine, arms-length transaction. His family, while inheriting a portion of his estate, lost out on substantial tax benefits, a painful consequence of inadequate planning. This highlights the risk of using poorly structured or undocumented notes to fund a CRT – the IRS can deem the asset’s value inflated or the transaction insincere.
What are the benefits of using a promissory note in a CRT?
Using a promissory note can be particularly advantageous when the donor wants to maintain control of an asset while still benefiting from a CRT’s tax advantages. For instance, a business owner might contribute a promissory note secured by company assets, allowing the business to continue operating while providing income to the CRT and ultimately benefiting a chosen charity. Furthermore, this strategy can unlock liquidity from illiquid assets without triggering immediate capital gains taxes. However, it’s critical that the note’s terms mirror a commercial transaction, with a reasonable interest rate (as defined by the Applicable Federal Rate or AFR), a clear repayment schedule, and adequate collateral. According to the National Center for Charitable Statistics, utilizing non-traditional assets in CRTs has increased charitable giving by an estimated 12% in the last decade.
How did a client successfully fund a CRT with a promissory note?
Recently, a local rancher, Ms. Eleanor Vance, approached Steve Bliss with a unique situation. She owned a substantial parcel of land but didn’t want to sell it immediately. Instead, she wanted to fund a CRT to benefit a local animal rescue. Working with Steve, they structured a promissory note secured by the ranch land, with a fair market interest rate aligned with the AFR. The note was meticulously documented, outlining repayment terms and collateral. The IRS approved the CRT, allowing Ms. Vance to receive an immediate income tax deduction, retain the use of her land for a period, and ultimately support a cause she was passionate about. This success stemmed from a well-structured note, thorough documentation, and expert legal guidance. A well crafted agreement not only minimizes risk but also maximizes the potential tax benefits and ensures the donor’s charitable intent is fully realized.
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