In this article we are going to be talking about an advanced tax strategy to help eliminate the capital gain tax on the sale of a highly appreciated asset.

A highly appreciated asset is simply one that you would expect a large gain on when you sell it.

Are you selling stock in your portfolio with a lot of gain? Maybe you are selling your business. Do you own some real estate you would like to liquidate?

These are all important transactions that can see 30-40% of the value eroded because of state and federal income taxes. What if you could preserve those taxes for the future? What if you could convert taxes into capital that would produce a significant income during your retirement years?

That is exactly what we are going to be discussing here. If you haven't already checked out our Blog, What Is Ordinary Income Tax vs Capital Gain Tax?, be sure to check that out to understand how those various tax pieces work.

What Is A Charitable Remainder Trust (CRT)?

It is a trust that is usually established to avoid tax on appreciated assets. A CRT has a unique advantage (compared to you) in which the trust can sell appreciated assets without paying tax on the capital gain from the sale. Then you can receive income from that trust for a period of time (or life) with finally at the end, the remainder given to charity.

A few things you should know:

1. You must implement this before you legally are committed to selling your property. Once you have a bona fide offer and you have accepted it, your ability to avoid capital gains taxes is gone. You must set this up be this up before you accept a legitimate offer. This is why it's important to be contact with a professional as soon as you are starting to think about a potential sale.
2. To set up a charitable trust, you need a legal document and a CRT administrator. You also need to establish a custodial arrangement to hold the asset until you sell. You transfer title to a proportion of the asset you are going to sell to the trust BEFORE you enter into your sale arrangement.

How Does A Charitable Remainder Trust (CRT) Work? 

Once the trust is created...

1. Typically you would start out by transferring an asset (like a business, real estate, stock, etc) to the trust as an irrevocable gift.
   • You will get a charitable deduction from that gift for the present value of the remainder interest passing to charity. You will want an appraisal here to determine how much of a charitable deduction you will get.
2. Next you have the trust (tax-exempt) sell the asset to avoid the tax.
   • Assume you are selling an asset worth $1MM. The likely tax on this would be $300,000, maybe more depending on where you live. If you put all of the asset into your new CRT – that net value in the trust is $1MM. You just saved $300,000 in tax.
3. Then the trust will distribute income to you based on the agreement. Typically this will be monthly, quarterly, semi-annually or yearly.
   • There are various different arrangements that can be setup related to this piece.
   • You will be subject to tax on your income distributions from the trust.
4. Finally at the end of the trust term, the trust remainder passes to a charitable beneficiary.
   • Many folks utilizing this strategy will also take some of the tax savings and purchase a form of life insurance to replace the equity that passes to charity at your death. There are many different setups and arrangements for this as well.

What Are Things to Consider With A Charitable Remainder Trust (CRT)? 

• You have no personal access to those funds after you put the asset into the trust. Your only access is from the income the trust will pay you each year.
• The eventual owner of the asset is a charity you can name now or later. You eventually give the money to as many legal charities as you want.
  • When does that happen? – it usually happens at the death of the last beneficiary of the trust. Since you will no longer need income from the trust, the trust is liquidated, and the money then goes to your charitable choices.
• Distributions can be set to happen after a set number of years, once the income begins. This could be set a 20 years. So if you start your income at age 70, the trust would liquidate at 90.
• Avoiding the gain on the sale is only one benefit – there is another benefit, you get a tax deduction for the amount of the gift to your charitable trust.
• The amount of the gift is determined by your age, how long the income will be received by you and the amount of income you want to have distributed each year.

What Different Types of Charitable Remainder Trusts (CRTs) Are There?

• You can select a guaranteed amount annually, called a CRAT – a charitable remainder annuity trust. This is established based on the amount of money you put into the trust.
• You can select a CRUT – a Charitable Remainder UniTrust. This type of trust pays out a fixed percentage of the trust assets each year. If the trust value increases, your income increases.
• There is another benefit to a special provision you can add to the trust – you can turn the income on and off. This is called a NIMCRUT – it is a unitrust that can skip years when you don’t need the income. NIMCRUT means a NET INCOME Makeup Charitable Remainder Unitrust. The makeup provision allows you to take larger income distributions based on how much is deferred.

What Are The Downsides Of A Charitable Remainder Trust (CRT)?

• Once you put your asset in the trust and it is liquidated, you are unable to reinvest that money directly – like you would if you had paid the tax.
• The tax deduction you get is a fraction of what you would be able to claim if you gave the money outright to charity. This is because you get income for life from it. The lower deductions reflect the income element of you plan.
• Are there limitations to your investment choices? Yes, you must be diversified. The investments need to meet the prudent man rule for trusts. So if you want to take risks with this money, it is probably better to use other dollars. The IRS wants the charity to eventually get value from this trust.

The benefits of a CRT, for the right person, outweigh the negatives. Let me point out again most people want income from their assets in retirement. That being the case, a CRT is a great alternative to consider.

You get a tax deduction for setting it up. You get tax free growth on the assets. Your income can be significant.

The CRT is a good option if you want an immediate charitable deduction, but also have a need for an income stream to yourself or another person. It is also a good option if you want to establish one by will to provide for heirs, with the remainder going to charities of your choosing. There are a variety of charitable giving vehicles from which to choose. 

Finally, be sure to contact a professional early on so you can ensure this is a strategy available for you. If you are interested in learning more or getting introduced to an expert we work with, shoot us an email.

Also do not forget to check out our Podcast with Guy Baker on this topic as well which you can find below.

Want An Introduction To Our Preferred CRT Vendor?

Send us an email at Ask [at] tax savings podcast [dot] com with "CRT" in the subject line!

We also did a deep dive into this strategy as part of our Tax Minimization Program which we highly recommend you checking out! Not only will you get access to this strategy, but so many more as well!