Charitable Remainder Trusts

Goal: Secure payments for life while reducing market risks.
Benefit: Potential increased income and tax benefits.

There are two different types of charitable remainder trusts.

A charitable remainder unitrust (see example) is a popular way to achieve tax benefits as well as a fixed annual percentage on the value of the assets in the trust. The assets are revalued annually and, if the trust value changes, the payment to the beneficiary(ies) changes.

Charitable Remainder Trusts (CRTs) Explained

Goal: Secure payments for life while reducing market risks. Benefit: Potential increased income and tax benefits.

A Charitable Remainder Trust is established for the life of the donor (also trustor or grantor) and/or for the life of any beneficiary(-ies) and is irrevocable. While there are certain changes that may be made, once the trust is established, it cannot be revoked. If it is desired, the income period of the trust can be established for a specified period of time not to exceed twenty years. The twenty-year maximum does not apply if the trust life is based on the life expectancy of the income beneficiary(-ies). Because the income is paid to one or more parties and, at the end of the trust's life, the principal and any undistributed interest is paid to a different party, a charitable remainder trust is called a split interest trust. The income portion of the trust may be either a unitrust income or an annuity income.

With a unitrust, the assets of the trust are revalued annually and the percentage rate established in the trust agreement determines the dollar amount of the unitrust interest. The unitrust interest amount would increase if the value of the trust assets increased. If the value of the principal in the unitrust declined, the amount of the interest portion of the unitrust would decline as well.

An annuity income is calculated at the time the trust is established in the trust agreement. It is a fixed amount of dollars based on the then market value of the trust. If the assets of the trust go up in value, the income portion does not change.A charitable remainder trust is an attractive planning tool for the disposal of highly appreciated assets. While the assets revert to the charity rather than the heirs of the estate, the use of an irrevocable life insurance trust in conjunction with a charitable remainder trust could replace the asset's value for the heirs.

Net Income Charitable Remainder Trust

This variation of a unitrust provides that either the specified fixed percentage of the trust assets or the net income of the trust is distributed to the beneficiary, whichever is less. This type of trust is often used to handle real estate as there is no fixed distribution requirement, giving the trustee time to arrange an orderly sale of the property. A net income charitable remainder unitrust can be an excellent way to donate appreciated property and turn it into an income stream as well as acquire tax benefits.

A donor may also add a 'makeup provision" to the trust. This allows a trust to distribute more than the fixed percentage of the assets in years where the trust's income exceeded the fixed percentage. In this manner, previous year's shortages, when the trust was not able to earn the fixed percentage payment, may be made up.
Flip Charitable Remainder Unitrust

A flip unitrust blends two types of trusts for greater flexibility, both for the donor and the eventual remainderman. The trust functions as a net income trust until a specified event occurs. On January 1st following the specified event, the net income trust flips and becomes a standard unitrust. This type of trust functions well for illiquid assets such as real estate or assets that are hard to value. See below for more information on flip unitrusts.

Flip Unitrusts Explained

Goal: Secure payments for life while reducing market risks. Benefit: Potential increased income and tax benefits Diagram.

A Flip Charitable Remainder Unitrust provides the flexibility necessary for some assets by combining aspects of a net income unitrust and a regular unitrust. It is an excellent approach for people with illiquid or unmarketable assets to fund a trust that will make an irrevocable commitment to their favorite charity (or charities).

The IRS created the Flip Unitrust in 1998. The regulations permit the trust to function without paying any income to the trust beneficiary (or beneficiaries). After a predetermined event, such as the sale of the asset funding the trust, the Flip unitrust "flips" (becomes) a regular unitrust on the following January 1st. Since the asset in this case has been sold, the trustee may invest in income-producing assets for the trust and may begin making regular income payments to the beneficiary (ies).

For example, suppose a donor owned real estate that she inherited some twenty years ago from her parents. Let's say her cost basis was only $10,000, but the development land had appreciated dramatically and had a current fair market value of $300,000. She felt a trust that would pay her 7% each year was very attractive to her. It also enabled her to provide a large charitable gift for a charity that was very meaningful to her, something she might not have been able to do otherwise. With real estate in a Flip Unitrust, the documents specify that the trigger event will be the sale of the property. Until the trustsells that property, the unitrust remained a net income trust. Since there is no current income from the property, the trust does not pay any income.

On January 1st after the trigger event (the sale of the property), the trust "Flips" and became a standard unitrust.

The donor will receive a steady income for her lifetime. She also avoided an immediate capital gain tax of $43,500 and perhaps saved some potential estate taxes by removing the property from her estate. And, she had the joy of knowing and informing her favorite charity that a significant gift had been made that they could look forward to.

A flip trust provides flexibility for donors with hard to value or illiquid assets. A flip trust can be managed so that illiquid assets may be sold in a tax advantaged manner, the proceeds reinvested in a balanced portfolio and life income payments received by the donor and/or other beneficiaries.

There will probably be expenses associated with a trust, especially a trust involving real estate (taxes, insurance, maintenance for example). The donor should recognize that prior to the trust generating income, the donor may need to make additional gifts to the trust in anticipation of the expenses.

There are many different types of events that can trigger the flip. The event cannot be discretionary and must be specified in the trust documents. Examples of some events that could be used to trigger a flip are:

  • A single event
  • Birth, death, marriage, or divorce
  • The sale of all or a specified part of an illiquid asset
  • A person reaching a certain age
  • A specific date
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For more information or a confidential discussion of your charitable options, please
email or call, Roxanna Prezioso, at (843) 777-2694.

Please note, individual financial circumstances will vary. The information on this site does not constitute legal or tax advice. Donor stories and photographs are for purposes of illustration only. As with all tax and estate planning, please consult your attorney or estate specialist. You may also contact a member of the Professional Advisory Council. All material is copyrighted and is for viewing purposes only. Use of this site signifies your agreement with the terms of use. The content in this Legacy Giving section has been developed for McLeod Health Foundation and is owned by Future Focus. Please report any problems to section webmaster.