InvestingRetirementTax Tips
Charitable Remainder Trusts (CRT): The “Tax-Exempt Sell & Compound” Engine
Charitable Remainder Trusts (CRT): The “Tax-Exempt Sell & Compound” Engine
โ ๏ธ STRATEGY DECLARATION
This strategy is widely accepted in professional practice, but valid only if the trust passes the actuarial “10% Remainder Test” and “5% Probability Test” at inception. Unlike a standard sale, the seller does not get lump-sum cash immediately; they get an income stream. It is a trade of “Liquidity” for “Tax Deferral & Yield.”
This strategy is widely accepted in professional practice, but valid only if the trust passes the actuarial “10% Remainder Test” and “5% Probability Test” at inception. Unlike a standard sale, the seller does not get lump-sum cash immediately; they get an income stream. It is a trade of “Liquidity” for “Tax Deferral & Yield.”
* Note: This is an L2 ($2M+) exit framework.
Core Definition: “A CRT is an irrevocable trust that allows you to transfer appreciated assets (Stock/Real Estate), sell them tax-free inside the trust, and receive an annual income stream for life. Whatever remains at death goes to charity.”
* Warning: Once the asset is in the CRT, you cannot take it back. You only own the “Income Stream,” not the “Principal.”
Core Definition: “A CRT is an irrevocable trust that allows you to transfer appreciated assets (Stock/Real Estate), sell them tax-free inside the trust, and receive an annual income stream for life. Whatever remains at death goes to charity.”
* Warning: Once the asset is in the CRT, you cannot take it back. You only own the “Income Stream,” not the “Principal.”
๐ WHO THIS IS FOR (Prerequisites)
- Required Profile: Investors holding highly appreciated assets (e.g., Apple stock bought in 1990, Apartment building owned for 20 years) with a near-zero cost basis.
- Primary Objective: Capital Preservation (Avoiding the 23.8% – 33% tax erosion upon sale to maximize the principal available for compounding income).
- Disqualifying Factor: Need for immediate lump-sum cash to buy a house or pay debt (The CRT locks up the principal).
โ ๏ธ STRATEGY ELIGIBILITY CHECK
This strategy works only if the math allows for a charitable remainder. It fails if:
- โ๏ธ The 10% Remainder Rule: The IRS requires that the present value of the “Charitable Remainder” (what the charity gets at the end) must be at least 10% of the initial contribution. If you are too young (e.g., 30) or payout is too high (e.g., 10%), you will fail this test, and the trust is disqualified.
- โ๏ธ Tiered Income Rules (WIFO): Income distributions are taxed based on “Worst In, First Out.” You are taxed on Ordinary Income first, then Capital Gains, then Tax-Free Corpus. You cannot cherry-pick the tax-free principal.
- โ๏ธ Unrelated Business Taxable Income (UBTI): If the CRT holds debt-financed real estate or an active business interest, it may trigger a 100% excise tax on UBTI (historically) or current tax rates. CRT assets should generally be debt-free.
EXECUTIVE SUMMARY
- The Problem: You have $2M of Tesla stock (Basis $10k). Selling it triggers ~$500k in taxes. You are left with $1.5M to invest for retirement.
- The Structure: You transfer the stock to a CRUT (Charitable Remainder Unitrust).
- The Mechanism: The Trust sells the stock for $2M. Tax Paid = $0. The full $2M is reinvested in a diversified portfolio.
- The Result: You receive 6% ($120k) per year for life. You get an immediate income tax deduction (~$200k).
- The Trade-off: When you die, the remaining principal goes to Charity, not your kids. (Unless you pair this with an ILIT #568 to replace the wealth).
“Don’t give the IRS a tip.” By using a CRT, you redirect the tax bill into your own income stream and a charitable cause. Source: Harvard University Planned Giving / Fidelity Charitable
๐ MODEL METHODOLOGY & ASSUMPTIONS
- Asset: $2,000,000 Zero-Basis Stock.
- Sale Tax Rate: 25% (Fed + State).
- Investment Return: 7.0%.
- Payout Rate: 6.0% (Unitrust).
- Term: 20 Years.
Performance Simulation (The Pre-Tax Compounding)
| Metric | Personal Sale (Taxable) | CRT Sale (Tax-Deferred) | Delta (Wealth Shift) |
|---|---|---|---|
| Gross Proceeds | $2,000,000 | $2,000,000 | – |
| Tax Bill Paid | ($500,000) (Gone) | $0 (Deferred) | Save $500k Principal |
| Investable Capital | $1,500,000 | $2,000,000 | +33% More Capital |
| Annual Income (6%) | $90,000 | $120,000 | +33% Higher Income |
| Total Income (20 Yrs) | $1,800,000 | $2,400,000 | +$600k Lifestyle Cash |
*Chart Note: The “Wealth Replacement” strategy involves using a portion of the extra $600k income to buy a Life Insurance Policy (ILIT) for the heirs. This creates a “Zero-Loss” scenario where heirs get the death benefit, charity gets the trust, and you get the income.
Advanced Mechanics: The “NIMCRUT” Spigot
*How to turn income on and off like a faucet.
| Type | Mechanism | Best Used When… |
|---|---|---|
| Standard CRUT | Trust MUST pay 6% of assets annually, regardless of income. | You need steady income immediately (Retirement Mode). |
| NIMCRUT (Net Income with Makeup) | Trust pays the lesser of 6% or “Net Income.” If income is $0, payout is $0. Deficits accrue to “Makeup Account.” | You are still working and don’t want income tax yet. You invest in non-dividend assets inside the trust. When you retire, you switch investments to high-yield and trigger the “Makeup” payout (The Spigot). |
Strategic Mechanics: “WIFO” Taxation
The Four-Tier Accounting System:
- Tier 1 (Ordinary Income): Interest, Dividends, Rents. (Taxed at highest rate). Distributed first.
- Tier 2 (Capital Gains): The gain from the initial sale. (Taxed at 15-20%). Distributed second.
- Tier 3 (Tax-Exempt): Muni bond interest. Distributed third.
- Tier 4 (Corpus): Return of Principal. (Tax-Free). Distributed last.
- Impact: You cannot access the tax-free principal until you have emptied all the taxable income buckets accumulated in the trust.
โ BOUNDARY CLAUSE: Operational Limits
- Self-Dealing: Just like a Private Foundation (#579), you cannot rent the building held by your CRT. It must be an arm’s-length investment.
- Grantor Trust Status: A CRT is NOT a Grantor Trust. It is a separate tax-exempt entity. This is why it can sell assets tax-free.
๐ค DECISION BRANCH (Logic Tree)
IF Goal = Leave Business to Kids:
โข Input: Asset must stay in family.
โข Output: Do NOT use CRT. Use IDGT (#563) or SCIN (#582). A CRT gives the asset to charity at the end.
IF Goal = Turn Concentrated Stock into Pension:
โข Input: No emotional attachment to the asset, just want value.
โข Output: Execute CRT. Maximize the principal, defer the tax, and secure a lifetime income stream.
“A CRT is simply a Tax-Exempt IRA that you can fund with $2 Million of Apple stock.”
Disclaimer: This content is for educational purposes only. CRTs are irrevocable. If the trust assets underperform the payout rate, the principal will deplete. Failing the “10% Remainder Test” or “5% Probability Test” disqualifies the trust retroactively. UBTI rules can be punitive. Consult a Tax Attorney and Actuary.