Trusts are pretty neat things. Set up properly they can be fantastic vehicles to give you tax deductions, relief from capital gain tax when selling appreciated assets, a great way to move wealth from one generation to another, and significantly lower your estate tax. They can be as simple as you like, or fantastically complex. It’s really up to you and your advisor to determine the type of trust that works best for your situation.
If you’re looking to create a legacy with your assets, then you might want to consider establishing a Charitable Remainder Trust. What this type of arrangement does is allow you to put income-generating assets into a trust, with a qualified charity named as the ultimate beneficiary. You are still able to live in the properties, or to keep the income stream from the properties, if they are developed, tenanted, etc. Upon your death, the corpus (principal) remaining in the assets (i.e., title and control) transfers to the charity.
You can structure the trust so that you are paid in one of several ways:
- A fixed-dollar amount;
- A percentage of the net fair market value of the trust;
- Actual income (with provisions for over/under payments in loss years and profitable years)
There are some great tax advantages here. For example, when you fund a CRT, you get to take a deduction equal to the current value of the property that will ultimately be transferred to the charity. Called the “remainder interest,” this deduction is calculated based on Internal Revenue Service tables of life expectancy factors. The older you are when the CRT is set up, the higher this deduction will be.
Another benefit to this strategy is the ability to sell off highly-appreciated land or otherassets while avoiding capital gain tax. Moving the assets into the trust first allows the trust to liquidate the property tax-free, and then allows the trust to reinvest the proceeds, securing both your income stream and, ultimately, the charity’s position.
How the CRT is taxed depends on what type of income it earned during the year (or what was undistributed from prior years). Each payment is treated first as ordinary income to the extent of the trust’s ordinary income; second, as capital gains to the extent of the trust’s capital gains; third, as tax-exempt income to the extent of the trust’s tax-exempt income; and last, as a tax-free return of principal.
Where you are the only income beneficiary, your charitable remainder trust will be free from federal estate tax. Because of the marital deduction, this is also true if your spouse is a U.S. citizen and the only surviving income beneficiary.
By finding a charity in line with your own philanthropic goals, creating a CRT would allow you to make a lasting contribution.