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Exempt Organizations

Exempt Organizations
January 2002

Stuck inside my CRUT...

The creation of a charitable remainder trust (CRT) requires donors to make some assumptions about the future performance of the trust assets. Changes in value may affect the amount distributable by the trust to the donors and/or the amount of assets that may ultimately pass to charity. Recent rulings highlight planning possibilities where the performance of the trust has exceeded initial expectations or there have been other changes in circumstances.

Background CRTs remain a popular charitable contribution tool. There are a number of significant benefits and planning goals that can be achieved through use of CRTs, including:

  • Sale of appreciated assets at reduced tax cost
  • Diversification of investments
  • Creation of a fixed income stream
  • Providing benefits to charity with an income tax charitable contribution

There are two types of CRTs—a charitable remainder unitrust (CRUT) and charitable remainder annuity trust (CRAT).

  • A CRUT provides that the amount distributable to the donor is determined as a percentage of the fair market value of trust assets, determined annually. With a CRUT, increases in the value of trust assets will result in increased distributions to the donor.
  • A CRAT provides that the distribution amount is fixed as a percentage of the fair market value of trust assets at inception. An increase in value in CRAT assets will not affect the amount distributable to the donor; all of the increase in value will benefit the charity.

Transfers of partial interests The charitable contribution rules prohibit a charitable contribution deduction for transfers of “partial interests.” Unless a donor transfers the entire interest in property, a charitable contribution is not permitted. This is the rule that prohibits a charitable contribution when a charity merely rents or uses an individual’s property.

A transfer by a donor of a portion of his or her entire interest in property is permissible; this is not a transfer of a partial interest. For example, a transfer by a donor of a 50% undivided interest in real property may qualify for a charitable contribution. The donor has transferred all of the rights and obligations associated with ownership of that 50% interest.

The provisions that allow for the creation of a CRT represent an exception to the general rule that a charitable contribution is not permitted for a “partial interest” in property. A CRT represents a transfer of a partial interest, since the creator is retaining the right to the income from the trust property, while the charity is receiving only the remainder interest.

A “second gift” of CRUT assets Upon creation of a CRUT, a donor receives a charitable contribution deduction based on the value of the remainder interest in trust assets as of the date of creation. The donor retains the income interest. The sum of the value of the income interest and remainder interest equals the fair market value of the trusts assets.

If the value of trust assets in a CRUT remains constant over time, the value of the income interest will decrease as the time period over which income is to be received is reduced. If the value of trust assets increases, however, the value of the income interest (and the amount of annual distributions to the donor) may actually increase.

Recent rulings have highlighted the opportunity for a donor to make a second gift to charity in a situation in which CRUT assets appreciate. Since the income interest that arises upon creation of a CRUT is itself a property interest, a donor can make a charitable gift of this income interest.

For example, in Private Letter Ruling (PLR) 200140027, the IRS permitted a surviving spouse/donor to split a CRUT into two separate trusts with terms identical to the initial trust. After the split, the donor assigned her income interest in one trust to the remainder charity, resulting in an acceleration of the payment of those trust assets to charity. The donor received a charitable contribution deduction based on the value of the income interest. The donor retained the income interest in the second trust.

This may be particularly beneficial where trust assets have appreciated and the donor does not need greater income than that which was projected at the inception of the trust. It provides an opportunity to transfer immediate benefits to charity and an additional charitable contribution for the donor. The increase in CRT assets may also enable the donor to designate additional charitable recipients.

The risk with the foregoing strategy is that the value of trust assets will decrease after the gift of the income interest; however, this is always the risk when using a CRUT. In PLR 200152018, this risk was mitigated when the donor transferred his income interest to a charity in exchange for an annuity.

Organizations who are the beneficiaries of CRUTs should be aware of the potential for accelerating gifts through transfer of income interests. In the right situation, the donor is left in essentially the same position as when the trust was created, but is able to claim an additional charitable contribution attributable to the increase in value of trust assets while providing an immediate benefit to the charity.

Private letter rulings are issued to specific taxpayers who submit ruling requests to the IRS. PLRs cannot be cited as authority by other taxpayers. While PLRs may provide an indication of how the IRS may rule in similar situations, taxpayers should consider obtaining a ruling from the service before implementing a charitable giving strategy involving transfer of income interests in a CRUT.

Should you have any questions regarding the foregoing, please contact John Kikuchi at (925) 944-7666 or by email.

The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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