What if I told you that you can defer capital gains tax when selling an appreciated asset, reduce estate taxes, and receive income from the sale — all at the same time?
Yes, this is possible with a Charitable Remainder Trust (CRT).
This strategy can be deployed in many situations, but it can be especially attractive for business owners who are looking for (1) a way to move appreciated investments out of their estate, and (2) a tax-efficient way to sell their business.
A heads up for the readers who believe (like many people do) that they have no “estate.” Anyone with assets in their name (or their business’ name) should have at least some parts of an estate plan created. The goal of estate planning is to lay out guidelines and wishes for where you’d like your assets to be distributed after you’re gone.
In other words, yes, you should keep reading!
Tax Strategy: Charitable Giving with a Twist
For the right business owner, a charitable remainder trust is a powerful estate planning tool. It can deliver tax-advantaged income — and set your desired charities up with a sizable donation.
Charitable remainder trusts have many moving parts, and it’s really hard to describe this strategy without talking through the terminology and mechanics first.
If you are more curious about the potential financial pros and cons, feel free to scroll past this section! For everyone else, we will be as brief as possible.
First, the grantor (the current owner of the assets) funds the CRT with appreciated assets through a transfer. Since the transfer is irrevocable, it removes the asset from the grantor’s estate forever. That means it won’t be subject to future estate taxes. At the same time, the grantor receives a charitable income tax deduction.
The trust can then sell the asset without incurring capital gains tax. This can save a substantial amount of money. It can also allow for the funds to be reinvested into a diversified portfolio for further growth. The new investments then pay out income to you (the grantor) during your lifetime. When you pass, the assets that remain in the trust go to the selected charitable beneficiaries.
For those who don’t have an appreciated asset to contribute right now, CRTs can still be effective by using what’s known as a “lumping strategy.” Rather than making smaller charitable contributions each year, you could lump them into one tax year. That strategy can allow you to take advantage of charitable deductions that you wouldn’t normally receive when making smaller contributions. And if you’re unsure about which charity you’d like to donate to, selecting a donor advised fund as the charitable beneficiary can allow you to sort out the recipient organization(s) in the future.
In practice, the strategy is complex. Rules and requirements must be followed precisely. Be sure to consult with a tax professional and/or an attorney to determine if a CRT is appropriate for your situation.
Advantages:
- Tax reduction potential across the board: income, capital gains, and estate.
- Option to make tax-advantaged charitable donations that benefit your charity of choice (or a donor advised fund until you choose one).
- Option to provide consistent income to lead beneficiaries, which can allow for some interim cash flow.
- Donated asset(s) gain protection from creditors.
Caution:
- CRTs are irrevocable, meaning that assets cannot be withdrawn after having been contributed to the trust. In other words, there’s no changing your mind on this.
- Administration and management of a CRT can be complex (and costly).
- The strategy generally requires large contributions to receive the worthwhile tax benefits.
- Distributions can be taken at any regular frequency but are generally made quarterly or annually. When taking distributions, the amount must be greater than 5% but less than 50% of the value of the assets within the trust. Payouts either last for a term not to exceed 20 years, or for the life of a non-charitable beneficiary.
Savings Range:
- The calculation: Capital gains rate x Avoided gain
- $1,000+ with significant upside potential
Good Business: The Use Case for a Charitable Remainder Trust
One of the biggest concerns when selling a business or other appreciated assets is the potential tax bill on the other side. By taking a proactive approach, you can plan ahead to determine the most cost-effective exit strategy that checks the boxes which matter the most to you.
Because trusts are not subject to immediate capital gains tax, any asset sold within a trust has more value and impact than if it were to be sold outside of a trust. Funds can then be reinvested and left to grow over time, making trusts an attractive tool for those looking to create income from an asset sale.
Charitable remainder trusts can provide significant advantages, but they aren’t the right fit for everyone. Those who benefit the most are typically the individuals who have highly appreciated assets that they’re ready to part with and who want to make a charitable impact with their money.
Because of its complexity and costs, it’s essential to speak with a trusted advisor, tax professional, and/or attorney before implementing this strategy. Here at TreMonte, we can help you figure out if you would benefit from incorporating a Charitable Remainder Trust into your overall financial plan. Reach out to a member of our team today!
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