The Tax-Wise Way to Cash in Taxable Investment Gains

There’s a strategy for recognizing taxable capital gains that produces multiple tax benefits for many people. The recent boom in stock prices and some real estate sectors leaves many people sitting on substantial gains.

They’d like to take the gains and reposition their capital before prices decline, without losing a good portion of the appreciation to capital gains taxes. The charitable remainder trust (CRT) is a strategy to consider. You don’t need property with substantial appreciation to benefit from a CRT, but having gains increases the benefits.

You create the trust, then transfer appreciated property to it. The trustee sells the property and reinvests the proceeds. You then receive a regular stream of income from the trust. The income lasts for life or a term of years, whichever you choose. The income can last for the joint life of you and a beneficiary, such as your spouse. After the income period ends, the assets left in the trust are transferred to a charity or charities you named.

One tax benefit of the CRT is that you incur no capital gains taxes on the transfer of the property to it because the trust is a charity. You will owe taxes, however, on the future income distributions, some of which will be taxed as capital gains.

Also, since the CRT is a tax-exempt charity, it pays no capital gains taxes on the sale of the property. The entire sale proceeds can be reinvested to generate future income and gains. The third tax benefit is you qualify for a charitable deduction equal to the present value of the amount the charity is estimated to receive when the trust is wound down. The present value de- pends on current interest rates and your age (or the number of years income is scheduled to be paid).

You need to itemize expenses on your tax return to take advantage of the deduction. A fourth tax benefit for those concerned about the estate tax is that the value of the trust is not included in your estate. There are two basic types of CRTs.

A charitable remainder unitrust (CRUT) pays annual income that is a percentage of the trust’s value at the start of the year. The income distributions vary with annual changes in the value of the trust. A charitable remainder annuity trust (CRAT) distributes a fixed amount each year. The distribution amount doesn’t change and loses purchasing power over time.

A CRUT has the potential to preserve your purchasing power if the investments do well. You set in advance the amount of income, or the percentage of the trust, distributed each year, within minimum and maximum limits the IRS establishes. With either type of CRT, only the trust assets back the promise to pay income. If the trust runs out of money, the distri- butions stop. Suppose Max Profits owns shares of a stock or mutual fund that he purchased for $250,000 some years ago. They now are worth $500,000. He no longer wants to own the shares but doesn’t like the prospect of paying $50,000 in federal capital gains taxes (20% of $250,000).

Max contributes the shares to a CRUT that will distribute 5% of the value to him or his wife, Rosie, each year as long as either is alive. He owes no capital gains taxes now and qualifies for a charitable contribution deduction of $170,130. The first year’s distribution will be $25,000, or 5% of the trust’s initial value, which will be at least partly taxable. Distributions after that depend on the trust’s investment returns. If Max had sold the property, paid capital gains taxes, and invested the after-tax proceeds, a 5% payout would equal only $22,500. Suppose instead Max chose a CRAT that would distribute $25,000 annually.

His charitable contribution deduction would decline to $167,320, and he or Rosie would receive $25,000 annually as long as either is alive. If Max sold shares and invested the $450,000 after-tax proceeds in a com- mercial annuity that paid income to him and Rosie for as long as either is alive, the annuity would pay $30,000 or more per year, according to quotes at stantheannuityman.com. The difference between the commercial annuity payout and income from the CRAT is the gift Max makes to charity and why he gets a charitable contribution deduction.

These examples are based on a particular scenario and using current interest rates. You can easily see free estimates of a CRUT or CRAT for your situation. Many universities and large charities have calculators on their websites that let you explore different scenarios with no cost or obligation. To develop the numbers in this article, I used the websites of my alma maters (Clemson University and the University of Virginia School of Law). Many university endowments and large charities will help set up the CRT, administer the trust and manage the portfolio without charge, provided they are named as a significant beneficiary.