Higher Interest Rates Increase Benefits of CRT

Interest rates are much higher than they were a year ago. That increases the tax benefits of certain strategies, such as the charitable remainder trust (CRT). There are many uses of a CRT. It can be used to convert highly appreciated investment property into a stream of income at a low tax cost. Another use is to reposition a traditional IRA, reducing future required minimum distributions and income taxes. A third use is to establish a lifetime stream of income, provide money for a charity and create some income tax benefits, all at the same time.

In the basic CRT, you create the trust and transfer money or property to it. The trust pays income to you, or other bene- ficiaries you name, for life or a period of years. After the income period, the trust is dissolved, and the remaining property is distributed to the charity or charities you named. There are income tax benefits when you transfer money or property to a CRT, and the CRT’s assets are excluded from your estate.

When you transfer appreciated in- vestment property to the CRT, you don’t owe any taxes on the appreciation that occurred while you owned the property. The CRT can sell the property and not owe income taxes on the appreciation, because the CRT is a charitable entity. The CRT reinvests the cash proceeds in a diversified portfolio and distributes regu- lar income to you or other beneficiaries.

The income generally will be taxable to the beneficiaries. The tax burden de- pends on the types of income earned by the trust and distributed to beneficiaries. You receive income tax benefits for funding the CRT, which I’ll discuss shortly. Another way to fund a CRT is to take a large distribution from a traditional IRA and donate the after-tax amount to the CRT. The deduction for donating to the CRT reduces the taxes on the IRA distribution.

This should reduce the lifetime taxes on the traditional IRA assets, pay you or other beneficiaries income for life or a period of years, and create a future bene- fit for charity. In addition, the CRT assets now are professionally managed. An alternative is to name a CRT as the beneficiary of your traditional IRA. In- come will be paid from the CRT to your named beneficiaries over time.

Benefi- ciaries can’t take the money in a lump sum and investments will be determined by the trustee. Those are only a sample of the ways a CRT can be used. There are double tax benefits when appreciated investment property from a taxable account is contributed to the CRT. One benefit, already discussed, is no capital gains taxes are imposed on the appreciation that occurred while you owned the property.

Another benefit from any contribution to a CRT is an income tax deduction of the estimated present value of the amount that eventually will go to charity (provided you itemize expenses on your Form 1040). The present value is estimated using tables from the IRS that incorporate life expectancy (or years the income will be paid) and current interest rates.

The percentage of the contribution to the CRT that’s deductible depends on these variables. The important fact today is that when interest rates increase, the estimated present value of the amount charity will receive increases. If you create and donate to a CRT today, you’ll receive a tax deduction substantially higher than the deduction you would have received a year or more ago.

Online calculators can help you esti- mate the tax benefits, income flow and other effects of a CRT. My alma maters, Clemson University and the University of Virginia School of Law, have good cal- culators and information on the alumni sections of their websites.

Most universities and other large charities with endowment funds will set up, administer and manage the invest- ments of your CRT for little or no cost if at least 50% of the charitable gift goes to them. Most estate planners can walk you through the details and help decide if a CRT is the appropriate estate planning vehicle for you. Be wary of firms that promote the use of CRTs.

Some are misstating the tax benefits, such as by claiming the charity will be able to increase the basis of do- nated assets to fair market value so future income distributions will be tax free. This and other CRT scams are on the IRS’s list of dirty dozen tax scams.