A CRT is an advanced estate planning method in which a highly appreciated asset is placed in an irrevocable trust to generate a lifetime income, provides an immediate tax deduction for the benefactor, while eventually benefiting a charity.
Our blog “What is an Estate Trust?” covers the basic principles of an Estate Trust. CRT is an advanced estate planning tool that benefits both the donor and a charity. It is setup when the Grantor transfers a highly appreciated asset, such as real estate or stock, to an Irrevocable Trust. Trustee sells the asset and reinvests the proceeds to generate a lifetime income for the Grantor or their kids. The Grantor can also be the Trustee thus retaining control over investment options. After their life, the remainder of the asset goes to charity.
The transfer of an asset to a CRT reduces the Grantor’s estate tax, and the sale of the asset in a CRT does not generate any Capital Gains. Taxes are covered in our blogs “Estate and Gift Taxes“ and “Income Tax Calculation Flow and Deductions.” A mortgaged real estate or an active business like a S Corp cannot be part of the CRT. The CRT asset is protected from the Grantor’s creditors.
The reinvested asset in a CRT has two interests: Income and Remainer. Income interest is the NPV (Net Present Value) of the future income stream and is calculated based on the current age and life expectancy of the person receiving income, and at a discount rate as specified in Section 7520. Remainder Interest is the initial FMV (Fair Market Value) of the CRT asset minus Income Interest. The Income Interest cannot be more than 90% of the CRT asset. The Grantor receives a charitable income tax deduction equal to the Remainder Interest regardless of the cost basis of the transferred asset.
A CRT can be setup to provide either a fixed income (CRAT or Charitable Remainder Annuity Trust) or variable income (CRUT or Charitable Remainder Uni Trust). A CRUT income will be based on a fixed percentage of the FMV of the CRT, which varies based on the performance of the CRT assets. For either income options, the IRS stipulates that the payout be between 5-50% of the FMV of the CRT. Income from the CRT is taxable to the recipient.
A CRT can help generate more income over your lifetime than if you had sold the asset yourself. Let us illustrate the point with an example. For example, Matt, who is 60, has a $1M investment property, which he acquired many decades ago for a small amount. If Matt sells the property himself, he would pay $250K in Capital Gains tax (assuming a combined 25% Federal and State tax rates). If he reinvests the rest of the proceeds in a conservative portfolio and withdraws 5% annually, his income would be $37.5K (5% of $750K). However, with a CRT, Matt could receive $50K (5% of $1M), which is 33% more income than without a CRT.
Using the actuarial table, if the Remainder Interest is 20% of the FMV of the property in the CRT, then Matt will also receive a tax deduction for $200K, boosting his retirement income. Of course, he would have relinquished control of the investment property. But Matt would enjoy a higher cash flow and the satisfaction of helping his favorite charity after his passing.
A CRT can be coupled with an ILIT (please refer to “Irrevocable Life Insurance Trust (ILIT)” for more details), in which the CRT income funds the premium of a Life Insurance policy placed in the ILIT. When the Grantor dies, the ILIT proceeds can effectively replace the gifted CRT asset for the estate.
We specialize in tax-free retirement strategy and investments such as IUL, Annuity and LTC. Prefer a quick and complimentary consultation? Just email us at Karthik@FinCrafters.com