What Are the Benefits of a Charitable Remainder Trust?

Through proper estate planning, you may be able to give charitable gifts to a cause you care about in a cost-effective manner. For many, one of the best options is a charitable remainder trust (CRT), which allows individuals to secure a lifetime income, save on estate taxes, and provide an income stream for a good cause.

You can set up a charitable trust in any state. However, some states have more favorable trust and tax laws for setting up a charitable remainder trust. For legal advice on where to set up a trust agreement that aligns with your interests, talk to a trusts and estates lawyer.

What Is a Charitable Remainder Trust?

A CRT is a tax-exempt trust that individuals can use to transfer property and/or trust assets to produce income and provide for charity. Notably, it is an irrevocable trust.

As an example of how a CRT works in practice, imagine that you have $200,000 in real estate property. If you want to donate part of the proceeds of this property to your favorite charity, a charitable remainder trust is a way to do so while also creating income and a charitable deduction for yourself or your family.

First, you would transfer the ownership of the asset in question to an irrevocable charitable remainder trust. The trust would then sell the property and turn it into cash. Importantly, the CRT does not have to pay capital gains taxes on the appreciated assets.

The proceeds and remaining trust assets would then be reinvested into an income-producing asset. For the remainder of your life, you would receive monthly income payments. When you pass away, your selected charities will get what remains in the trust.

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Annuity vs. Unitrusts

Although trusts are normally a function of state law, charitable trusts that wish to take advantage of certain tax benefits must also comply with Internal Revenue Service regulations. A charitable trust in this context usually refers to a “charitable remainder trust” (CRT). To establish a CRT, you transfer certain assets into an irrevocable trust — i.e., you cannot remove the assets from the trust after completing the transfer.

Initially, the trust’s assets are to benefit a non-charitable beneficiary, such as yourself, your spouse, or your children. After a certain specified period of time, the trust terminates and the “remainder” is distributed to an IRS-qualified charitable cause.

The IRS generally recognizes two types of CRTs — annuity trusts and unitrusts. Here is a brief explanation of how the two charitable planning types differ:

Charitable Remainder Annuity Trust

In a charitable remainder annuity trust (CRAT), the trust pays the non-charitable beneficiary a fixed dollar amount or a fixed percentage of the trust’s assets each year. This amount must be between five and 50 percent of the trust’s assets, based on the original fair market value at the time of transferring the assets into the CRAT.

The payments must first be taken from the trust’s income, but if that is insufficient, the trustee must use the trust’s principal, subject to certain IRS regulations.

Charitable Remainder Unitrust

With a charitable remainder unitrust (CRUT), the trustee also makes an annual distribution to the non-charitable beneficiaries based on a fixed percentage (between 5 and 50%) of the trust’s assets. There is a revaluation of the assets each year prior to distribution.

A CRUT is also often structured to provide the income beneficiary with the lesser of the trust’s net income or the fixed percentage. The CRUT also permits the trust to “make up” in future years for prior distributions where the net income was less than the fixed percentage.

The Benefits of a CRT

For certain individuals and families, a CRT is a useful estate planning tool, both for its ability to save some money and to provide for charity. Specifically, some of the key advantages of a charitable remainder trust are as follows:

1. Ongoing Income: A charitable remainder trust allows the grantor to set up a lifetime source of income for themselves or a loved one. How much income depends on the value of the assets and how exactly you structure the trust; it can be annual payments or other arrangements.
2. Tax Savings: Of course, you could sell an asset and reinvest the proceeds on your own—but you will miss out on important tax savings. With a CRT, you can sell assets without paying capital gains taxes. The trust creator also receives an immediate charitable income tax deduction in the year they create a CRT.
3. Support a Good Cause: A charitable remainder trust allows you to provide some financial support to a charitable organization that is important to you and your family.

To obtain these tax benefits, you must set up a charitable remainder trust in the proper manner. These are complex estate planning vehicles, and there are a number of different pitfalls, such as non-compliance with IRS regulations, that you need to avoid.

How a CRT Actually Affects Your Taxes

Under IRS rules, at least 10% of the “fair market value” of the property originally placed in a CRT must go to a qualified charitable beneficiary. If you or your beneficiary expects to live a very long time, a CRT may not be right for your situation. The trust might not have enough assets left over for the charity.

But assuming everything goes as planned, a CRT can have significant tax benefits. For one thing, as the person funding the trust, you receive both income and gift tax deductions for the remainder that goes to charity. Additionally, the annual payout you receive from the CRT is subject to federal income tax, and beneficiaries must report this income on their tax returns. 

Know that the income will be categorized based on the trust’s earnings. While you cannot revoke a CRT or remove property from it, you can generally reserve the right to change the charitable beneficiary. Please note that you cannot change the fixed percentage or annuity amount of the annual payout once the trust is established.

“We do recommend them to some clients as being an appropriate estate planning tool,” says Abby Wool Landon, an attorney at Wool Landon in Portland.

“If you’re going to use the charitable trust to both get your charitable deduction and avoid the capital gains tax on the sale of a business—and you want to contribute your business interests to the charitable trust—you have to plan far ahead for signing any sale documents of the business,” says Landon.

“Keep in touch with your trust & estate advisor. Know that, once you’ve signed that letter of intent or you’re in the middle of a purchase or sale agreement, it’s too late to avoid the IRS making an accumulation-of-income argument.”

Find Legal Help

These are complex entities that involve specialized knowledge of federal and state tax laws. That is why you should never attempt to establish any kind of charitable trust without first consulting a qualified lawyer. For legal help creating a trust that works best for your situation, contact an experienced estate planning attorney.