While appreciated assets are what all investors hope for over time, they often come with big tax implications. Capital gains tax on stock, property and other assets can be daunting, so investors can get creative on how they sell their appreciated assets. We often advise clients on creating Charitable Remainder Trusts – in order to donate appreciated assets, avoid heavy capital gains tax, and make a charitable impact with their money at the same time. Here’s how it works and why investors should consider it.

What assets can you transfer into a Charitable Remainder Trust (CRT)?

You’ll want to create a Charitable Remainder trust with highly appreciated assets like real estate, public stocks, some private equity, retirement accounts and other complex, substantial assets. S-Corporation stock cannot be put into CRTs, only partnership interests or C-Corporation stock, but there is no limitation on the amount of ownership that can be transferred. You can even transfer cash, but the most enticing part of a CRT is the ability to minimize capital gains tax on appreciated assets, something you won’t get by just donating cash.

How does a Charitable Remainder Trust work?

A Charitable Remainder Trust allows you to transfer appreciated assets into a trust that pays at least one beneficiary annually and at the end of the payment term, the trust passes to one or more qualified U.S. nonprofits. According to the IRS, “The remainder donated to charity must be at least 10% of the initial net fair market value of all property placed in the trust.”

There are two ways to structure a charitable remainder trust. Which one you select will depend on the value of your assets, if you plan to contribute more assets later, and how you wish beneficiaries to receive income from the trust. 

Option 1: CRAT

Charitable remainder annuity trust

Payments: Fixed dollar sum paid to beneficiary each year

Contributions: Only one, initial contribution of assets allowed when the trust is created 

Option 2: CRUT

Charitable remainder unitrust

Payments: Fixed percentage of trust assets paid to beneficiary each year

Contributions: Additional contributions of assets allowed throughout life of the trust

In addition, there are two types of CRUTS we often advise, especially when contributing stocks to the trust. Dividends paid on stocks can be unpredictable, so regardless of how much a stock has appreciated, cash to pay beneficiaries isn’t available until dividends are paid or the stock is sold. Therefore, a NICRUT (Net Income Charitable Remainder Unitrust) allows for beneficiaries to be paid only in years that cash flow from the assets allows. Similarly, a NIMCRUT (Net Income Makeup Charitable Remainder Unitrust), only issues payments when cash flow allows, but will also keep a running tab of missed annual payments to be made up in the future when cash flow from the assets allows.

What are the tax benefits of a CRT?

As with most things accounting, it’s easiest to show you the numbers. Below is an example comparing the tax obligation if you sell an appreciated asset, like real estate, versus if you were to transfer it into a CRUT with 5% annual payments to the beneficiary.

If You Sell the Asset: If You Put the Asset in a CRT:
Market value of appreciated asset $500,000 $500,000
Cost Basis $50,000 $50,000
Capital Gain $450,000 $450,000
Estimated Capital Gains Taxes

(20% Federal + 3.8% Net Investment Income Tax (NIIT))

$107,100 $0
Total Amount to Invest at 5% $392,900 $500,000
Immediate Income Tax Deduction NA $50,000, (benefit of $18.5K assuming 37% tax rate)
Income to CRUT Donor at 5%* NA $25,000

*Note this income is still taxable, but you get the time value of money by paying the tax over time.

As you can see, if the investor doesn’t need the cash now, receiving payments over time from the trust significantly reduces their immediate tax obligation. 

What are the biggest limitations to a CRT?

There are two limitations we discuss often with our clients. One is that the trust is irrevocable, once it’s set up, there’s no removing the assets and legally, you no longer own them. We only advise CRTs for high net worth individuals who don’t need the proceeds from their appreciated assets for current living expenses. They want the ability to defer paying the tax, and having more current assets to invest with. 

Another limitation is making sure you’re holding assets with minimal UBTI (unrelated business taxable income). Assets with investment income are ideal for a CRT, not assets with high operating income. Operating income can be categorized as UBTI meaning it can be taxed at regular tax rates and therefore is not protected by the tax status of the trust. Putting your ownership of an operating business into a CRT would be okay if it was for a short period of time (the year before a sale). Putting your ownership of an operating business into a CRT would be okay if it was for a short period of time (the year before a sale). However, you wouldn’t want to hold the ownership of an operating business long-term.

If you have highly appreciated assets and are hoping to spread their impact over time to a charitable organization, we can help. In collaboration with our attorney partners, we can help you explore setting up a charitable remainder trust and make sure the structure minimizes your annual tax obligations. Schedule a call with us today to learn more.