Capital gains taxes are a dreaded side effect of having the assets you’ve invested grow substantially, and the options are fairly limited on how to avoid paying for them. The new federal capital gains tax is now 23.8% – including the 3.8% Medicare surtax for high earners. A Charitable Remainder Trust (CRT) may be a great alternative that avoids capital gains taxes, moves assets out of one’s estate, and provides a substantial legacy for a charity.
Many assume the best way to avoid capital gains taxes is to hang on to the asset, and let it transfer to the heirs, as it would receive the step-up in cost basis at death. There are a few problems with this type of planning, however. If the appreciated assets are no longer earning a beneficial rate of return compared to other alternatives, there is a lost opportunity cost. If the owner has a sizeable estate and may be facing estate taxes, holding onto the assets may avoid the capital gains taxes with the step up in cost basis, but may subject the assets to even greater federal and state estate taxes.
A Charitable Remainder Trust allows an individual to transfer assets into the trust without using any estate exemptions, and then allows those assets to be sold without incurring capital gains taxes. After selling the appreciated asset, the trust is then structured to pay you either a fixed percentage of the principal, or a fixed dollar amount. The payout must be structures in such a way that at least 10% of the initial value passes on to the charity, based upon life expectancy.
This planning is typically structured in conjunction with a Children’s Trust that holds a life insurance policy to replace the value of the asset that was donated to the Charitable Trust. The policy premiums are paid with a portion of the distributions that the CRT pays out, and the death benefit is held outside of the estate, avoiding estate taxes.
In addition to meeting a client’s philanthropic intentions, a Charitable Remainder Trust can provide an efficient way to avoid paying capital gains taxes on highly appreciated assets. It also removes those assets from the estate without incurring estate taxes, and can be used in conjunction with a children’s trust to provide the heirs with a much more substantial estate.