A charitable remainder trust (“CRT”) is an irrevocable trust that pays an annual amount to a non-charitable beneficiary or beneficiaries for some time, measured either by the beneficiary’s life or over a specified term. At the end of the lifetime or specified period, the trust property is transferred to one or more charities.
A CRT can be established during the lifetime of the grantor or upon the death of the grantor. If the grantor creates a CRT during their lifetime, the grantor will receive an income tax deduction, and the CRT itself will be treated as a tax-exempt entity.
While the income and capital gains generated by property held in the CRT will not be taxed to the CRT, it must be accounted for. When distributions are made to the non-charitable beneficiaries, they will receive allocations of trust income and/or capital gains to the extent of their distributions.
What is a CRAT or CRUT?
There are two basic types of CRTs. A charitable remainder annuity trust (“CRAT”) is a CRT that pays a specific amount annually to the non-charitable beneficiary or beneficiaries either for life or a specified term of years. The amount of the annuity payment does not change over time.
A charitable remainder unitrust (“CRUT”) pays the non-charitable beneficiary or beneficiaries a percentage of the value of the CRUT property each year. The percentage is set upon the creation of the trust and does not change. However, as the value of the trust property changes over time, the payments to the non-charitable beneficiaries will correspondingly increase or decrease depending on the value of the CRUT property from year to year.
The income tax deduction to the grantor upon the creation of an inter vivos CRT is calculated utilizing the fair market value of the assets transferred to the CRT reduced by the estimated present value of the annual payments to be made to the non charitable beneficiaries based on the beneficiaries life expectancies utilizing the 7520 rate. The present value of the charitable remainder interest must be at least 10% of the initial fair value of the assets contributed directly to the CRT.
Strategies & Advantages
CRTs are often used to allow a grantor to diversify appreciated property without incurring a capital gain tax. The appreciated property is contributed to the CRT, and following the contribution, the CRT can sell the property without facing a capital gains tax. However, once the CRT begins making distributions to the non-charitable beneficiaries, the non-charitable beneficiaries will recognize the ordinary income and capital gains previously avoided by the CRT, but only to the extent of the distributions they receive.
Therefore, to the extent distributions are made to the non-charitable beneficiaries, the income and gains of the trust are deferred until the distributions are made; and to the extent that the income and gains of the CRT are not distributed to the non charitable beneficiaries, the tax on that portion of the CRTs income and capital gains will be avoided.
Even though the CRT is an irrevocable trust, the grantor can retain the power to change the charitable beneficiaries and the power to change the trustee.
For those individuals who have a charitable intent and own appreciated property, a CRT can be a useful technique to minimize their capital gains and fulfill their charitable intentions.