October 31, 2016
Many of my clients are charitably inclined and want to leave a legacy behind. Often, these same clients may own highly appreciated assets, such as rental properties purchased years ago, or stocks that have a low basis. The outright sale of those highly appreciated assets will trigger significant capital gains tax – not an attractive option. However, clients are often reluctant to make outright immediate gifts of those appreciated assets for fear it will leave them without enough assets and income for their future needs. For those charitably inclined clients with highly appreciated assets who are concerned about losing potential income, a charitable remainder trust is great vehicle to accomplish their goals.
How a charitable remainder trust works is relatively straight forward. A donor transfers property to a trust retaining an income interest for his/her life or lives, with the remainder passing to charity at the death of the last beneficiary. For example, a married couple with a significant amount of low-basis stock, contributes some or all of those shares to a charitable remainder trust. The shares can then be sold in the trust and the proceeds can then be reinvested in a more diversified portfolio. The couple is then entitled to distributions from the trust in an annual amount of at least five percent (5%) of the value of the trust’s assets for their joint lives. So even after the death of the first spouse, the surviving spouse would still receive distributions. Then upon the death of the surviving spouse, the remaining assets would go to the charity or charities designated by the donors.
Not only does the charitable remainder trust satisfy the client’s charitable wishes, but also provides the client significant tax benefits. The client will get an immediate income tax deduction for the actuarial value of the remainder interest that is projected to go to charity. If the charitable deduction for that tax year exceeds the deductible ceiling for that year, those excess charitable deductions can be carried forward for a period of five (5) years. Also, when that highly appreciated asset is sold in the charitable remainder trust, the client will not have to immediately recognize all those capital gains. Instead, the client will recognize only some of the capital gains each time they receive a distribution from the trust, effectively allowing them to avoid a large one-time capital gains hit, and to defer that capital gains tax over a longer period of time. Immediate income tax deduction and deferral of capital gains tax are very attractive aspects of the charitable remainder trust.
Charitable remainder trusts can come in several forms. There are charitable remainder unitrusts (CRUTs) which are required to pay a fixed percentage of its fair market value to the non-charitable beneficiaries on an annual basis. This fixed percentage must be at least five percent (5%), but no more than fifty percent (50%), of the fair market value of the trust’s assets determined annually. There are charitable remainder annuity trusts (CRATs) which are required to pay a certain amount on an annual basis to the non-charitable beneficiaries. That certain amount must equal at least five percent (5%), but no more than fifty percent (50%), of the fair market value of the trust assets, valued only as of the date the assets are transferred to the trust.
Charitable remainder trusts are not the right vehicle for everybody. First and foremost, the individual must be charitably inclined. The desire to support a cause, or organization, or to leave a legacy, should be the paramount concern. However, at a time when the stock market is nearing all-time highs and property values in many areas are increasing, the ability to defer capital gains taxes is an enticing aspect of these trusts. Add in the immediate income tax deduction for the actuarial value of the remainder interest and the ability of the donor to retain a stream of income, and the charitable remainder trust becomes a very attractive and effective vehicle for the charitably inclined.