Charitable remainder annuity trust: so much winning!

Have you considered a Charitable Remainder Annuity Trust in your estate plan? If not, perhaps you should do so before tax laws change.

Perhaps you have an asset that has appreciated significantly since you received or purchased it, but it doesn't provide you with any current income. You'd like to find avoid capital gains tax - even though the top rate is now only 20% (plus the 3.8% Medicare surtax from the Affordable Care Act). Maybe you've thought about this problem before, but it now seems more urgent now that President Biden is proposing to raise the top capital gains rate to 43.4% (including the Medicare surtax).

Maybe you're also looking for an additional source of income.

Let's suppose that you have a gross estate above the current deduction level of $11.7m. Clearly, you have achieved some modicum of success. As such, you are thinking about your legacy and would like to leave your mark by giving to charity. But, you didn't become successful without always looking for a way to benefit yourself or your family.

So, if you sold the asset, you'd incur substantial (and likely increasing) capital gains taxes. If you kept it and it remained in your estate, your estate would likely owe substantial (and likely increasing) estate taxes.

You could donate the asset to charity today. With that generous donation, you would receive a charitable deduction on your income taxes. As an ancillary benefit, you would also reduce the size of your estate (which may be especially front of mind as proposals to decrease the exemption level before 2026 - when it reverts back to $5m per person automatically - and perhaps to a lower level, like perhaps $3.5m).

You're savvy however, and you don't want to miss out on the potential for income from the asset if you simply donated it outright.

The Benefits of a Charitable Remainder Annuity Trust

With a Charitable Remainder Annuity Trust ("CRAT"), you can solve all of your issues by:

1. Offloading a highly appreciated asset;
2. Reducing the size of your estate;
3. Benefitting from a current deduction on your income taxes;
4. Tapping into income from a previously non-income producing asset;
5. Furthering your values through your choice of charity;

With a CRAT, you avoid paying capital gains tax on the asset's appreciation. You avoid paying estate tax on the asset when you pass - and you reduce the size of your estate by the current fair market value of the asset. With your donation of the asset to a CRAT, you receive a deduction on your income taxes. You also turn a non-income producing asset into a stream of income for life or some other specified term. Finally, you can signal to your children and the community your values through your choice of charity.

The Mechanics of a Charitable Remainder Annuity Trust

Perhaps an example will help keep your attention. Suppose that Grandma Milly gave you a piece of ranch land, Rainbow Ridge Orchard, in East Texas in the 1980s in her estate, valued at the time of transfer at $55,000. You nearly forgot about the Orchard until recently because the wells all ran dry years ago. Nonetheless, for sentimental reasons at first - and neglect, you held on to it. Well, after years of talking about it, just after Thanksgiving last year, you finally hired an appraiser to go out and look at Rainbow Ridge Orchard and give you a fair price.

It turns out that the ranch land in Texas is getting more valuable lately. And Rainbow Ridge Orchard is no exception. The appraiser valued the Orchard at $1.65m.

That's an appreciation of $1,595,000. That Grandma Milly, of yours sure was something else.

So, you'd transfer Rainbow Ridge Orchard to a Charitable Remainder Annuity Trust. The Trust would then sell the Orchard. From the proceeds, you would receive an income stream for either a specified term or lifetime (actuarially calculated). The trust would calculate the amount of the income stream based on expected length of the income stream and the expected rate of earnings. There's a caveat that the annual income stream cannot be less than 5% of the asset's value. The annual income stream could be as high as 50% of the asset's value, as determined by the specified term and the prevailing interest rate at the time of the transfer.

The CRAT would sell the Rainbow Ridge Orchard. However, the CRAT would not owe any tax because of its charitable status.

From the proceeds of the sale, the CRAT would then pay out the chosen annuity stream to you for the specified term.

A the end of the specified term, the remaining funds would go to the charity of your choice.

The Benefits of a Charitable Remainder Annuity Trust

For our example, by transferring Rainbow Ridge Orchard to a CRAT nicely solves all of the problems you encountered at the beginning of this post. Suppose that you are 74, and therefore have a life expectancy of about 12 years. You would receive a stream of income of about $82,517 for each of those 12 years. Overall, you would receive $990,198 in income. These figures use the §7520 rate for the current month at 1.2%, and an annual appreciation of the Trust funds at 5%.

At the end of the 12 years, the charity of your choice would receive $1,649,737.

So, you took a non-income producing, highly appreciated asset and turned it into an income stream of nearly $1m for yourself, $1.6m for the charity. You also received a capital savings of $319,000, and a deduction of $773,031.

If this sounds like something that you would like to take advantage of, you should reach out to an Estate Planning Attorney in Austin. This is a complex technique that requires careful adherence to the IRC § 664(d)(1).