Charitable remainder trusts allow you to transfer highly appreciated assets into an irrevocable trust and receive a partial income tax deduction. The trustee then sells the asset, pays no capital gains taxes, and invests the proceeds in income-producing assets.
The trustee pays you or other beneficiaries (or income beneficiaries) a fixed amount each year or a percentage of the trust’s yearly asset value.
What is a Charitable Remainder Trust?
Whether you have built a sizable estate or wish to receive more income, learning what is a charitable remainder trust may be your solution. It allows you to transfer appreciated assets into a tax-free trust that pays you or other beneficiaries a fixed percentage of the trust’s annual investment return. The charitable donation to UF is the difference between the annual dividend amount and the fair market value of the trust assets.
The first step is to select an asset (such as cash, securities, real estate, or tangible personal property) and determine how to allocate the proceeds from its sale. You will also determine if you want the trust to pay you for life or a term of years. You can also name multiple income beneficiaries and reserve the right to change them.
Types of Charitable Remainder Trusts
Donors can establish a charitable remainder trust (CRT) by transferring assets to the trust. The trustee of the CRT will manage the assets and disperse income payments to one or more beneficiaries. You, a trusted friend, a financial adviser, or an institution can administer the CRT. Choosing a charitable beneficiary, selecting a trustee, and determining the terms of the trust are critical to ensuring that the donor’s philanthropic goals and heirs’ needs are met.
A donor can use a CRT to earn a lifetime income stream, diversify their investment portfolio, and avoid capital gains tax on the sale of appreciated real estate. A donor can choose to distribute a fixed percentage of the trust’s value to one or more beneficiaries for life or a term of years and reserve the right to make additional contributions over time.
A CRUT is the most common type of CRT, and it allows donors to receive yearly lifetime payments based on a defined percentage of the trust’s assets, as revalued each year. This option is often used with illiquid assets, such as real estate or stock in private companies. A CRUT can also have a “flip unitrust” provision, which allows the trust to convert to a straight CRUT upon a triggering event. For example, a triggering event could be the trustee’s sale of an illiquid asset.
Tax Benefits of a Charitable Remainder Trust
Charitable Remainder Trusts are used to avoid capital gains taxes when selling highly appreciated assets. Using these vehicles to sell the assets and then reinvesting those savings into an investment account allows you to save 50% or more on taxes while increasing your return on capital by leveraging the power of compounding.
CRTs may be funded with cash, securities, real estate, and private company stock. The partial tax deduction the trustor receives is based on the type and term of the CRT, as well as projected income payments to the noncharitable beneficiaries and IRS interest rates.
After the trust terminates, all remaining assets pass on to charity. The donor selects the charitable remainder beneficiaries; they can be a single person, family members, friends, or a group (e.g., a family foundation). The donor can also retain the right to change the charitable remainder anytime.
Creating and managing CRTs can involve complex state laws, rules, and regulations and requires the guidance of a professional. As a result, donors are advised to consider alternative charitable giving strategies, such as donor-advised funds or charitable gift annuities, that can offer similar benefits and may require lower costs to establish and manage.
Disadvantages of a Charitable Remainder Trust
A charitable residual trust (CRT) is an irrevocable trust that allows you to give assets while receiving annual income for years or your entire life. The leftover assets are distributed to a qualified charity specified by the donor at the end of the trust term. The donor can receive an immediate tax deduction by giving a remainder interest gift of at least 5% and no more than 50% of the initial value of the trust property. The trustee may be the donor, a third party, or a corporation. The donor can also retain the right to change the trustee and the charitable remaindermen.
The CRT offers several benefits for donors, including federal and state income tax deductions, no capital gains taxes, and the ability to take fixed or variable distributions. The CRT can be created using cash, securities, real estate, or other appreciated assets.
While the advantages of a charitable remainder trust are significant, carefully considering all aspects of this type of planning is essential. Some disadvantages include reduced asset control, potential lower income, strict IRS regulations, and limited asset eligibility. Donors interested in philanthropic planning should also consider alternative strategies, such as a private foundation or donor-advised fund.