What Is a Charitable Remainder Trust?
A CRT benefits both private individuals and a charity. The donor or another named beneficiary receives payments during the trust term. When that payment period ends, the remaining trust assets pass to the charitable organization or organizations named in the trust document.
The trust may last for the life of one or more beneficiaries or for a term of up to 20 years. The trust itself is generally exempt from income tax on its investment activity, but beneficiaries may owe tax when they receive payments.
How CRT Income Payments Work
There are two main types of charitable remainder trusts.
Charitable Remainder Annuity Trust
A charitable remainder annuity trust, or CRAT, pays a fixed dollar amount at least annually. The amount is based on the value of the assets when the trust is created. For example, a CRAT funded with $1 million and using a 5 percent annuity rate might pay $50,000 each year to the income beneficiary.
The payment is predictable, but it usually does not increase or decrease if the trust grows. As a result, inflation may reduce the payment’s purchasing power over time. A CRAT also generally cannot accept additional contributions after it is created.
Charitable Remainder Unitrust
A charitable remainder unitrust, or CRUT, pays a fixed percentage of the trust’s value, which is calculated at least annually. The dollar amount paid to the income beneficiary can therefore rise or fall as the value of the trust changes.
For example, a 5 percent CRUT valued at $1 million might pay $50,000. If the trust value later falls to $800,000, the payment would fall to $40,000. If the trust grows to $1.2 million, the payment would rise to $60,000.
A CRUT offers more potential for payments to keep pace with investment growth, but the income is not a fixed dollar amount. The trust document may also include special provisions that affect how payments are calculated. These provisions require careful drafting and administration.
Potential Charitable Remainder Trust Tax Benefits
Deferring Tax on Appreciated Assets
One potential benefit is the ability to defer recognition of gain when the trust sells appreciated property.
Suppose you bought stock for $100,000 that is now worth $600,000. If you sell it personally, the sale may produce a substantial capital gain. If you transfer the stock to a properly structured CRT before a sale, the trust can generally sell the asset and reinvest the proceeds without immediately recognizing the entire gain for tax purposes.
The gain is not erased. Instead, it is generally recognized over time as the trust makes payments to the beneficiaries. This may allow the trust to diversify the assets and create an income stream without requiring the donor to pay tax on the entire gain in the year of sale.
The timing and structure of the transaction matter. A transfer made after a sale is already legally binding may have different tax consequences from a genuine transfer made before a sale is arranged.
A Partial Charitable Deduction
A donor who creates a lifetime CRT may qualify for a charitable income tax deduction. The deduction generally reflects the present value of the charity’s expected future interest, not the full value of the property transferred to the trust.
The calculation depends on factors such as:
- The value of the assets transferred
- The selected payment rate
- The ages of the income beneficiaries
- The length of the trust term
- Applicable federal interest rates
- Whether the trust is a CRAT or CRUT
Adjusted gross income limits may restrict how much of the deduction can be used in a particular year, although carryforward rules may apply.
A tax professional should calculate the expected deduction before the trust is created. The deduction should not be treated as an automatic dollar-for-dollar tax benefit.
An Income Stream
A CRT can convert a large asset that produces little or no current income into payments for the donor, a spouse, or another beneficiary. The payments may last for life or for a specified number of years.
This can be useful for someone who wants to:
- Supplement retirement income
- Create income after selling a business or another appreciated property
- Diversify a concentrated investment
- Wants to provide income for a spouse or another beneficiary
- Plans to make a substantial charitable gift
The amount and reliability of the payments depend on the trust type, payment rate, investment performance, and trust terms.
How CRT Payments Are Taxed
CRT payments are generally reported to beneficiaries on Schedule K-1. They are taxed under an ordering system that looks first to the trust’s income and gains.
In general, payments are treated as coming from these categories in the order listed:
- Ordinary income
- Capital gains
- Other income, including tax-exempt income
- Trust principal
This means payments may be taxable for many years before any portion is treated as a tax-free return of principal. The actual result depends on the trust’s investment, income, gains, and prior distributions. The IRS provides additional information about taxes on CRT income payments.
Important Limitations and Risks
The transfer is irrevocable. You generally cannot take the assets back for use as though you still owned them outright. Before creating a CRT, make sure you will have enough assets outside the trust for living expenses, emergencies, healthcare, and long-term care.
Payments are not guaranteed to meet your needs. A CRUT payment can decline when the trust’s value falls. A CRAT payment may be fixed, but the trust still depends on investment performance and sufficient liquidity. A high payout rate may provide more current income while leaving less for charity and increasing the risk that the trust will not last as planned.
The charitable deduction may be smaller than expected. The deduction is based on the projected value of the charity’s future interest. It is not necessarily equal to the value of the assets transferred.
Administration can be expensive and complicated. CRTs involve complex calculations, legal documents, investment management, recordkeeping, tax reporting, and annual filings. Trustee, legal, accounting, appraisal, and investment fees can reduce the amount available for beneficiaries or charity. The IRS requires CRTs to file Form 5227, and beneficiaries must receive tax information on Schedule K-1.
Be cautious of anyone who claims a CRT will eliminate taxes, guarantee unusually high income, or allow you to keep personal use of trust assets. A legitimate CRT should serve a genuine charitable and financial planning purpose.
Who Might Consider a Charitable Remainder Trust?
A CRT may be worth exploring if you:
- Own substantially appreciated assets
- Want to diversify an investment or sell property while spreading tax recognition over time
- Need income for yourself or another beneficiary
- Have a strong charitable objective
- Can permanently give up the remaining trust assets to charity
- Have enough assets outside the trust for future needs
- Are willing to handle ongoing administration and expenses
A CRT may be less suitable if you need complete access to the assets, want to leave those assets directly to family members, or have limited liquid resources. It may also be a poor fit if you do not have a clear charitable plan.
Frequently Asked Questions
Does a Charitable Remainder Trust Eliminate Capital Gains Tax?
Usually, no. A properly structured CRT may defer recognition of gain when it sells appreciated property, but the gain is generally recognized as payments are made to the beneficiaries.
Can Family Members Receive CRT Payments?
Yes. The CRT may name a spouse or another family member as an income beneficiary. Payments must follow the trust document and applicable tax rules.
How Long Can a CRT Last?
A CRT may last for the life of one or more beneficiaries or for a term of up to 20 years, depending on the structure and trust terms.
Can I Change My Mind After Creating a CRT?
No; a CRT is irrevocable. Although limited administrative or beneficiary changes may be possible in some situations, the donor normally cannot simply reclaim the assets.
Get Advice Before Creating a CRT
A charitable remainder trust may combine income planning, tax deferral, and charitable giving into one strategy. It also involves permanent transfer of assets, investment risks, and ongoing administration.
Before moving forward, ask an estate planning attorney, tax professional, and financial adviser to review:
- The assets you plan to transfer
- Your income and cash-flow needs
- The proposed payment rate
- The expected charitable deduction
- The tax treatment of distributions
- Trustee and administration costs
- Your spouse’s and family’s needs
- Your long-term care and estate plan
A CRT should be created only after you understand both its potential benefits and its permanent tradeoffs.
