When properly implemented, a charitable remainder trust is one of the best tax strategies to defer tax, increase cash flow and obtain a charitable income tax deduction when selling highly appreciated assets such as real estate.
A charitable remainder trust is an irrevocable trust established by taxpayers with charitable intent. The taxpayer will donate the property to the trust and name an income beneficiary and final charitable beneficiary.
The income beneficiary can be the taxpayer, spouse, child or another individual. More than one income beneficiary can receive set payments from the trust or a set percentage of the worth of the property for a defined term. The trust document determines how long the beneficiary will receive income from the trust or until the beneficiary dies. The final beneficiary is the charity which receives the remainder of the assets.
A charitable remainder trust can turn highly appreciated assets into cash without paying capital gains tax. The taxpayer donates an asset to the charity using a charitable remainder trust, which sells the asset at fair market value and retains the proceeds. The taxpayer benefits with an immediate charitable contribution income tax deduction.
The charitable contribution income tax deduction is determined based on the present value of the charitable organization’s remainder interest. This is calculated as the value of the donated property minus the current value of the annuity payments to the income beneficiary. The IRS provides life expectancy tables for taxpayers to calculate the deduction.
There are two types of charitable remainder trusts based on how they pay beneficiaries. Both trusts can be created while the taxpayer is alive or upon death.
Charitable remainder annuity trusts (CRATs) pay the beneficiaries a specific dollar amount yearly. The amount must be at least 5% and no more than 50% of the property’s value in the trust when it was established. A charitable remainder unitrust (CRUT) pays a percentage of the current value of the property in the trust yearly. The payments generally must equal at least 5% and no more than 50% of the assets’ fair market value, valued annually.
Charitable remainder trusts can offer many benefits, including: helping taxpayers plan major donations to charities, providing predictable income for life or over a specific time period, allowing taxpayers to defer income taxes on the sale of assets transferred to the trusts and allowing taxpayers a charitable contribution income tax deduction.
Before creating the charitable remainder trust, taxpayers must consider potential drawbacks. The charitable contribution deduction is less than had the taxpayer donated outright to charity. There is no access to the assets in the trust. The charity will eventually own these.
