Charitable Remainder Trust: Sell Appreciated Assets, Avoid Gain, Get an Income Stream

How a CRT Works

A Charitable Remainder Trust is an irrevocable split-interest trust under IRC §664. The mechanics:

1. Transfer appreciated asset to the CRT: You contribute property (stock with a low basis, real estate, business interest) to the trust. No gift tax if you are the income beneficiary. No capital gain recognized at this point.
2. CRT sells the asset tax-free: The trust is tax-exempt under IRC §664. When the trustee sells the appreciated asset, no capital gains tax is recognized inside the trust. The full proceeds are reinvested.
3. You receive an income stream: The trust distributes a fixed percentage of trust value (CRUT) or a fixed dollar amount (CRAT) to you each year — for your life, the life of another beneficiary, or a term up to 20 years.
4. You receive a charitable deduction: In the year of contribution, you get a deduction equal to the present value of the remainder interest passing to charity — typically 20%–50% of the contributed amount.
5. Charity receives the remainder: At the end of the trust term, the remaining assets pass to the designated charity.

CRAT vs. CRUT: Which Structure?

• Charitable Remainder Annuity Trust (CRAT): Pays a fixed dollar amount each year (must be at least 5% of initial fair market value). Does not fluctuate with trust performance. No additional contributions after initial funding.
• Charitable Remainder Unitrust (CRUT): Pays a fixed percentage of trust assets revalued annually (must be at least 5%). Distributions increase if trust grows; decrease if trust shrinks. Additional contributions permitted. More flexible — preferred by most planners.

The Capital Gains Bypass: The Core Benefit

The most powerful use: selling a highly appreciated asset inside a tax-exempt trust. Example: you own real estate worth $2M with a $200K basis. Selling outright: $1.8M gain × 23.8% (20% + 3.8% NIIT) = $428,400 in federal capital gains tax.

Inside a CRT: the trust sells the property for $2M, pays zero capital gains tax, and invests the full $2M. At a 6% CRUT payout, you receive $120,000/year in income. Over 20 years: $2.4M in income distributions. You also got an upfront charitable deduction of approximately $400,000–$600,000 depending on your age and IRS discount rate.

Taxation of Distributions

Distributions from a CRT are taxed using a "four-tier" ordering rule under IRC §664(b): ordinary income first, then capital gains, then tax-exempt income, then return of principal. The capital gains tax is not avoided permanently — it is spread over the distribution period as you receive payments.

However, the deferral and reinvestment of the full pre-tax proceeds creates significant time-value benefits. Spreading $428,400 of gain over 20+ years of distributions generates substantially more wealth than paying it all in year one.