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The US Agriculture Economy

While some areas of the Midwest had late plantings due to a wet spring and summer temperatures reaching record levels, many farmers will have a good harvest in 2011. Both the corn crops in the central part of the nation and the spring wheat may have good yields per acre and a solid price in the fall agricultural markets.

The United States is blessed with a very high percentage of usable agriculture land. Particularly in the Midwest, but also in the South, the Northwest and the Far West, the farm belt is a very strong and productive enterprise. American farmers annually produce a surplus of farm products that is exported worldwide.

With the growth of world population and demand for additional food by a growing world middle class of over 500 million people (mostly from Asia), the USA farm belt is likely to be planted to the fence lines. It seems very probable that the agricultural economy will be entering another "Golden Age" and there is no foreseeable end in sight. It is highly probable that both crop quantity and crop prices will be very positive during the coming decades.

The Economy and Farmer Jones

While each farmer is pleased that the overall agricultural economy is sound, the topic of primary interest is how his or her farm will operate. Most farmers in America operate on a cash basis. John and Mary Farmer usually plant crops in the spring, cultivate, fertilize and spray crops as needed during the summer and harvest in the fall. The costs of production are typically deducted and the revenue from the crops less costs represents the profit or net income from the farming operation.

When farm production is good, the farmer will typically sell a portion of the crop to recover all costs for machinery, seed, fuel, fertilizer, pesticide and other items. The balance of farm products is then the surplus or the profit potential.

Surplus or Profitable Crops

After the farmer has sold a sufficient portion of the crop to cover expenses, there is generally zero cost basis in the remaining crop. Since it has been severed from the land, the crop now is tangible personal property and frequently is in storage, at least for a period of time.

What are the characteristics of a stored crop? Whether it is corn, wheat, soybeans or other types of crops, it typically has zero basis, is readily portable and may be sold within a day or two in the usual market for that commodity. As such, this crop represents a prime unitrust candidate.

The Green Unitrust

Crops are a type of tangible personal property that may be used to fund a charitable remainder unitrust. Crops are generally inventory for the farmer and thus would usually produce ordinary income when sold. In order to bypass this ordinary income, the farmer could transfer the crops into a charitable remainder unitrust.

To fund a charitable trust with crops, there must be documents of transfer. Because it is essential to transfer the corn, wheat, hay, soybeans or other crops into the trust and then sell tax-free through the trust, three documents should be created. The first document is a deed of gift. It is a simplified version of a deed of real property. A format for a deed of gift follows.

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Deed of Gift

I, John Farmer, owner of EIEIO Farm and the following agricultural products, hereby irrevocably give and transfer the products described by type, quantity and location, to First Bank as Trustee of a Charitable Remainder Unitrust dated 7/4/2008, for the initial benefit of John and Mary Farmer.

Property Location, Quantity and Description

50,000 Bushels of Corn currently stored in Bin #104 on EIEIO Farm, Green County, Illinois.

Affirmation

I, John Farmer, state that the above crops are unencumbered, that they are the products of EIEIO Farm and I have full authority to irrevocably transfer these items to First Bank as trustee. First Bank shall have full and complete rights to hold, move, sell or otherwise manage the above property.

In Witness Whereof, I have signed this Deed of Gift on ______________, _________.

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John Farmer

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The second document is a receipt to be signed by the transportation company. It acknowledges the ownership by the unitrust and confirms that the transfer is under the control of the trustee. Finally, the third document is a confirmation of the sale by the elevator operator or other purchaser. Once again, the purchasing party states that the sale has been completed by the trustee on behalf of the trust.

Charitable Tax Deductions

When tangible personal property is transferred into a unitrust, two rules impact the charitable deduction. First, the transfer of assets into a unitrust creates an "intervening interest" under Sec. 170(a)(3). This section was created to preclude deductions for claimed "gifts" of art in which the donor retained possession of the donated art for a period of time. The charitable deduction is effective after the donor actually relinquishes possession of the art and transfers it to the charity.

With a charitable remainder trust, Sec. 170(a)(3) causes the deduction to be delayed until the asset is sold. At that time, there is no longer an "intervening interest," since the asset has been converted to cash.

The second rule relates to unrelated use regulation. When tangible personal property is transferred to a charitable remainder unitrust, the asset is always deemed to be an unrelated use. Therefore, the deduction is limited to cost basis times the applicable unitrust factor. The unitrust deduction factor for a remainder interest will consider the payout and duration of the trust.

Bypassing Ordinary Income

The principal benefit of a tangible personal property unitrust is the ability to defer recognition of ordinary income. If a farmer, rancher, manufacturer or other person holds an ordinary income asset, it may be desirable to create a unitrust to receive that asset. Even though there may be very modest or no charitable deduction, the avoidance of ordinary income tax on sale of the asset could be a very substantial saving.

Since the tangible personal property unitrust will have largely Tier 1 ordinary income when the asset is sold, it is customary to use a separate trust for the tangible personal property and a second unitrust for land, stock or other capital gain property. The tangible personal property unitrust will pay out fully taxable ordinary income.

However, the "capital-gain" trust funded with land or corporate stock may be invested under the four-tier structure. A portion of the earnings from this trust could be regular ordinary income. But the balance of the earnings could be qualified dividends or recognized long-term capital gain, both taxable at 15% for federal purposes. Thus, the tangible personal property unitrust should be separate from a unitrust that holds capital gain assets.

Example – "Green" Unitrust

John Rancher has an excellent crop this year. He sold most of his corn crop, recovered all expenses and has a current profit. In addition, John has 50,000 bushels of corn in his storage bin. Because he has recovered his costs, there is zero basis on the 50,000 bushels. Since the corn is inventory, if he were to sell the federal and state income tax rate is 41%. John uses a Deed of Gift to transfer the corn into a charitable remainder unitrust. To minimize any potential risk with respect to prearranged sale, his financial advisor serves as initial trustee. The financial advisor immediately has the corn transported to market and sold. Under Sec. 170(a)(3), John's deduction is delayed until the corn is sold. The corn is sold for $350,000. Since this is a gift of tangible personal property for an unrelated use, the deduction is limited to cost basis. Because the cost basis is zero, there is no charitable income tax deduction. However, John and Mary Farmer saved the 41% tax on the sale and effectively "banked" the $350,000 value tax-free. John and Mary will now receive income for two lives from the trust. Because the value of their income for two lives may exceed the after-tax value from an outright sale, the "Green" unitrust is an excellent solution for John and Mary Farmer.

"Green" Unitrusts

When flying over America, there are thousands of square miles of green crops beneath the plane. A "Green Unitrust" should be a primary financial planning method for many thousands of these farmers. It will enhance their personal financial security while helping to protect America's environment.