One possible strategy for dealing with highly appreciated property such as raw land, a family business, or employer stock, is to use a Charitable Remainder Trust (CRT). A Charitable Remainder Trust is an irrevocable trust created to provide an income stream to the income beneficiary, while a charity receives the remainder value when the trust terminates. There are a number of different types of CRTs available and many technical rules apply, but generally Charitable Remainder Trusts work as follows:
- First a donor establishes an irrevocable CRT and funds it; typically with highly appreciated assets, naming a charitable organization as the remainder beneficiary.
- Since charitable gifts are excluded, the donor owes no gift tax, nor does he use any of his lifetime gift tax exemption.
- The donor receives an immediate income tax deduction for the amount of the present value of the charitable organization’s remainder interest (a complex calculation based on the donor’s life expectancy, the adjusted payout rate, and a federal interest rate).
- The trustee the donor selected sells the highly appreciated assets and reinvests the proceeds into income-producing assets. The sale can be done without paying the capital gains tax that would have otherwise been required immediately.
- The trustee must pay the donor an income stream from the trust as either a fixed dollar amount (Charitable Remainder Annuity Trust) or fixed percentage amount (Charitable Remainder Unitrust). The initial amount must be at least 5%, but not more than 50% of the trust’s value.
- The income stream distributed to the donor is taxed on a pro-rata multi-tiered system with portions of each payment being ordinary income, capital gains, and tax free distributions of principle.
- Finally, upon termination of the Charitable Remainder Trust, the remainder in the CRT is given outright to the charity.
A property owner can receive the benefits of diversification, while continuing to enjoy an income stream off of their former property. He/she will also receive an income tax deduction today, while paying the capital gains tax due over their lifetime, rather than immediately.
The remaining funds do not go to loved ones; they go to a charity instead. However, this type of estate planning arrangement could also be paired with a life insurance policy to replace the value of the property being given to the CRT. Part of the mandatory distribution from the CRT could be used to pay the premiums. Furthermore, if the donor establishes an irrevocable life insurance trust (ILIT) to purchase the life insurance, then the death benefit will not be subject to estate tax upon the insured’s death.
When using a CRT and/or other estate planning strategies, it is frequently possible for all the stakeholders – property owner, loved ones, charitable organization – to win. Careful consideration should be given before an owner establishes and gifts property to a CRT. You must determine if the financial and tax benefits are satisfactory to the owner and how the CRT may impact inheritance issues. The Certified Financial Planners®
at Pension Consultants, Inc. can assist you in analyzing your situation, and developing a plan of action. The process may also require the aid of a qualified trust attorney, to properly draft the documents needed for your situation.
PCI’s archived blog entries are dated, the rules and statutes referenced may have changed. The analysis or guidance within these blog entries may have become stale, dated, or no longer accurate. PCI will not update or change these entries to reflect the latest analysis or development.