A charitable remainder trust is an irrevocable trust used in estate planning to move appreciated assets out of your taxable estate, pay you or another beneficiary income for life or for up to 20 years, and then transfer whatever remains to a charity you name. The structure gives you three tax advantages at once: an immediate income tax deduction for the projected value of the charitable gift, deferral of capital gains when the trustee sells the funded assets, and an estate tax deduction under Section 2055 for the remainder interest passing to charity.1Office of the Law Revision Counsel. 26 USC 2055 – Transfers for Public, Charitable, and Religious Uses The rules live in Internal Revenue Code Section 664.
What a CRT Does for Your Estate
Because the trust is irrevocable and its remainder is legally committed to charity, the assets you place in it fall outside your taxable estate at death. Your estate then claims a Section 2055 deduction equal to the value of the charitable remainder interest. For someone whose estate would otherwise sit above the federal exemption, that combination can meaningfully cut what heirs owe.
The tradeoff is control. Once funded, you cannot pull the assets back. You can retain the income stream, name a spouse or other individual as a co-beneficiary or successor beneficiary, and in most trust documents reserve the right to change the charitable remainder beneficiary later. What you cannot do is treat the trust as your own account.
The Income and Capital Gains Side
The upfront income tax deduction is calculated as the fair market value of the property you contribute minus the present value of the income stream you keep.2Internal Revenue Service. Charitable Remainder Trusts The IRS uses the Section 7520 rate in effect at the time of transfer to run the numbers, and a higher rate produces a larger deduction because it raises the projected value of the charitable remainder.
How much of that deduction you can use in one year depends on what you put in. Cash contributions to a CRT with a public charity as remainder beneficiary are subject to the 60% of adjusted gross income limit. Long-term appreciated property like stock or real estate is capped at 30% of AGI. Anything you cannot use carries forward for up to five additional tax years.3Office of the Law Revision Counsel. 26 U.S. Code 170 – Charitable, Etc., Contributions and Gifts
Capital gains are where a CRT often earns its keep. A CRT is tax-exempt under Section 664(c), so when the trustee sells appreciated assets inside it, no capital gains tax is due at the sale.4Office of the Law Revision Counsel. 26 USC 664 – Charitable Remainder Trusts The full proceeds stay invested. The gain isn’t erased; it is spread across the distributions you receive over the trust’s life, which usually means smaller annual bites at lower brackets.
How Distributions Get Taxed to You or Your Heirs
Every dollar paid out of a CRT is taxed under a strict four-tier ordering rule in Section 664(b). Each payment draws from the top tier first, and the next tier only opens once the one above it is empty.
- Tier 1, ordinary income: distributions are taxed as ordinary income to the extent the trust has current and accumulated undistributed ordinary income.
- Tier 2, capital gains: once ordinary income is exhausted, distributions are treated as capital gains from the trust’s current and prior years.
- Tier 3, other income: this catches tax-exempt income and anything not falling into the first two categories.
- Tier 4, return of principal: anything beyond the first three tiers comes back tax-free as a return of your original contribution.
In practice, early years often produce ordinary income treatment. As the trust ages and the ordinary income bucket empties, more of the payment can shift to the more favorable capital gains rate. A CRT funded with highly appreciated stock benefits most: the built-in gain gets metered out across years of distributions rather than realized in one taxable event.
Choosing Between a CRAT, CRUT, NIMCRUT, or FLIP
Four structures dominate. The right one depends on whether you want predictable income, growth potential, or a way to hold an illiquid asset that isn’t producing cash yet.
Charitable Remainder Annuity Trust
A CRAT pays a fixed dollar amount, locked in at creation. Fund a trust with $1 million and choose a 6% payout, and you receive $60,000 every year regardless of what the investments do.2Internal Revenue Service. Charitable Remainder Trusts You cannot make additional contributions to a CRAT after funding, and inflation can erode a long-term fixed payment. CRATs also face a probability of exhaustion test: under IRS guidance, there must be less than a 5% chance the annuity will drain the trust before the charity’s interest vests.
Charitable Remainder Unitrust
A CRUT pays a fixed percentage of the trust’s value, revalued each year. The same $1 million trust at a 6% unitrust rate pays $60,000 in year one, more if assets grow, less if they fall.2Internal Revenue Service. Charitable Remainder Trusts A CRUT accepts additional contributions over its life, which makes it more flexible for donors who plan to add assets later.
Net Income with Makeup Unitrust
A NIMCRUT pays the lesser of the trust’s actual net income or the stated unitrust percentage. Shortfalls in low-income years accumulate in a makeup account, and the trustee pays out the surplus in later years when income exceeds the unitrust amount. This works well when you fund the trust with an asset that isn’t producing income yet, such as undeveloped real estate or restricted stock.
FLIP Unitrust
A FLIP CRUT starts as a NIMCRUT and converts to a standard unitrust when a defined triggering event occurs. Treasury regulations require that the trigger be spelled out in the trust document and cannot rest on anyone’s discretion.5eCFR. 26 CFR 1.664-3 – Charitable Remainder Unitrust Permissible triggers include the sale of an unmarketable asset, a beneficiary reaching a specific age, marriage, divorce, the birth of a child, a death, or a fixed calendar date. The conversion takes effect at the start of the tax year following the trigger. The structure is popular when a donor contributes a closely held business interest or real property that will eventually be sold.
Rules the Trust Must Meet to Qualify
Section 664 sets several mathematical tests that must be satisfied at inception. Miss one and the trust fails to qualify, which means no deduction and no tax-exempt status.
The annual payout to the income beneficiary must be at least 5% but no more than 50% of the trust’s value. For a CRAT, that percentage is applied to the initial net fair market value of the property contributed. For a CRUT, it is applied to the trust’s net assets each year as revalued.
The present value of the remainder going to charity must equal at least 10% of the net fair market value of the assets placed in the trust. The IRS actuarial tables in Publication 1457 do the calculation using the beneficiary’s age, the payout rate, and the Section 7520 rate at the time of creation.6Internal Revenue Service. Publication 1457 – Actuarial Valuations Version 4A Higher payout rates, younger beneficiaries, and lower Section 7520 rates all push the projected remainder down. A 45-year-old asking for a 10% payout over life may find the remainder falls below the threshold.
If the trust runs for a term of years rather than a life, that term cannot exceed 20 years. A life or joint-lives structure has no fixed year cap.
Setting One Up
Decisions Before Drafting
Identify the income beneficiaries by name, with dates of birth for the actuarial calculation. Name at least one qualified charity as remainder beneficiary. Decide whether to keep the right to substitute a different charity later. Pick a trustee to manage investments, make distributions, and file returns. You may serve as your own trustee, but many donors use an independent or corporate trustee to avoid any appearance of self-dealing. Identify the specific assets you plan to contribute; non-publicly-traded property like real estate or a closely held business interest requires a qualified appraisal for IRS reporting.
Drafting and Executing
The IRS publishes sample trust documents, including Revenue Procedure 2005-52 for an inter vivos unitrust for one measuring life, with alternative provisions.7Internal Revenue Service. Internal Revenue Bulletin 2005-34 Most estate planning attorneys start from these IRS-approved forms, which reduces the risk of a technical disqualification. The document is signed and notarized. Once executed, the trust exists but holds nothing.
Funding the Trust
Funding means retitling assets into the trust’s name. Securities move through a letter of instruction and a copy of the trust agreement sent to the brokerage. Real estate requires a new deed prepared and recorded with the county. The trustee applies for a federal Employer Identification Number so the trust can open bank accounts and file returns.8Internal Revenue Service. Get an Employer Identification Number
Annual Filings
Every CRT files Form 5227, the Split-Interest Trust Information Return, each year.9Internal Revenue Service. Instructions for Form 5227 The return is due April 15 of the year after the tax year, with extensions available through Form 8868.10Internal Revenue Service. Return Due Dates – Other Returns and Reports Filed by Exempt Organizations The trustee also issues Schedule K-1 statements to income beneficiaries reporting the character of their distributions under the four-tier system.
Traps That Can Blow Up the Plan
Two IRS rules deserve real attention because either one can undo the tax benefits you built the trust to capture.
If a CRT produces any unrelated business taxable income, the trust owes an excise tax equal to 100% of the UBTI. Common triggers include debt-financed income from leveraged real estate and income from an active trade or business run through the trust. The practical rule: keep UBTI-generating assets out of the CRT.
CRTs are split-interest trusts, which brings them under the private foundation self-dealing rules of Section 4941.11Internal Revenue Service. Self-Dealing and Other Tax Issues Involving Charitable Remainder Unitrusts A transaction between the trust and a “disqualified person” — the donor, the donor’s family, or entities they control — triggers an initial excise tax of 10% of the amount involved, imposed on the disqualified person for each year the violation stands uncorrected. If the transaction is not unwound within the correction period, an additional 200% tax follows.12Internal Revenue Service. Taxes on Self-Dealing – Private Foundations Borrowing from the trust, leasing property to it, or selling assets to it all qualify. Excess business holdings and jeopardizing investments carry their own penalties.
Treat the CRT as what it is: a separate entity with its own tax identity, its own charitable purpose, and its own guardrails. Handled that way, it can move a significant slice of an estate to heirs’ benefit and to charity’s benefit at the same time.