Part III · Structures · No. 11

Charitable-remainder trusts

A split-interest trust that pays an income stream to non-charitable beneficiaries for a term or for life, with remainder to a qualified charity. Contributions of appreciated luxury assets can be sold within the trust without current income-tax — converting a 28% collectibles event into a stream of trust distributions and a partial deduction.

What the structure is

A charitable-remainder trust under §664 is an irrevocable trust paying:

• CRAT (Charitable Remainder Annuity Trust) — a fixed annuity amount (at least 5% of initial contribution) annually for a term of years (up to 20) or for life.
• CRUT (Charitable Remainder Unitrust) — a fixed percentage (at least 5%) of trust value, revalued annually.

The remainder, on termination, passes to one or more qualified charities. The settlor (or named non-charitable beneficiaries) receives the income stream; the charity receives the remainder.

The tax problem it addresses

The CRT solves three problems simultaneously:

• Income-tax deferral on appreciated-asset sale. Contribute appreciated art or collectibles to the CRT; the trust sells without current income-tax (CRTs are tax-exempt under §664(c) for income within the trust). Sale proceeds reinvested produce diversified income to fund the unitrust or annuity payments.
• Partial charitable deduction. The donor receives an income-tax charitable deduction for the present value of the remainder interest, computed using §7520 rates and the trust's payout terms.
• Estate-tax removal. The contributed assets and their appreciation are outside the donor's gross estate (the donor retains only the income interest).

Mechanics

The donor establishes an irrevocable trust meeting §664 requirements:

• Annuity (CRAT) or unitrust (CRUT) payment of at least 5% to non-charitable beneficiaries.
• Maximum payment ceiling — 50% under TCJA-era rule reform.
• Term of years (up to 20) or for life of named beneficiaries.
• Remainder of at least 10% (present value) to qualified charity.
• 5%-probability test for CRATs (Notice 2004-36 alternative): the probability of corpus exhaustion before termination cannot exceed 5%, or alternative qualifying provisions apply.
• Qualified appraisal for non-cash contributions.

Tax treatment of distributions under §664(b): four-tier ordering — ordinary income, capital gain, tax-exempt income, principal — based on the trust's income character. Distributions retain the character of the trust's income, with stacking through the tiers.

The applicable statutes and authorities

• 26 U.S.C. §664 (charitable-remainder trusts).
• 26 U.S.C. §170(a), (e) (deduction for charitable contribution to CRT).
• 26 U.S.C. §7520 (valuation tables).
• Treas. Reg. §1.664-1, -2, -3, -4.
• Rev. Proc. 2005-52 and 2005-53 (specimen CRT forms).
• Notice 2004-36 (alternative to 5%-probability test for CRATs).
• Atkinson v. Commissioner, 309 F.3d 1290 (11th Cir. 2002) (5%-probability test enforcement).

Substance and audit risk

• 10% remainder test. The present value of the remainder, computed using §7520 rate, must be at least 10% of the contributed value. High payout rates and long terms can fail this test.
• 5%-probability test (CRAT). Most CRAT structures use the Notice 2004-36 alternative; failure of either route disqualifies the trust.
• UBTI in the trust. Income from a trade or business or debt-financed property within the CRT can produce unrelated business taxable income; pre-2007 rules disqualified the trust entirely for UBTI in any year. The §664(c)(2) rule now imposes a 100% excise tax on UBTI rather than disqualification.
• Self-dealing. Donor's transactions with the trust must satisfy §4941 self-dealing rules applicable to private foundations and CRTs alike.
• Valuation. Contributed property is valued under qualified appraisal; aggressive valuations have produced audit and litigation.

Cost and complexity

Drafting cost is meaningful (CRTs are technical instruments). Trustee fees (institutional or individual) are ongoing. Annual valuation for CRUTs adds cost. Annual Form 5227 filing. For trust sizes below low-seven-figures, the administrative cost may be material relative to benefit.

Common combinations

• Net income with makeup CRUT (NIMCRUT). Distribution limited to lesser of unitrust amount or actual income; deficit is made up in later years when income exceeds unitrust amount.
• Flip CRUT. Begins as NIMCRUT, flips to standard CRUT upon a defined triggering event (e.g., sale of contributed illiquid asset).
• Charitable-lead trust (CLT). Mirror image — current charitable interest, deferred non-charitable remainder. Used for opposite tax-planning purpose.
• Combined with appreciated art or wine contribution. Sale within trust avoids 28% collectibles tax; trust pays unitrust to donor; remainder funds family foundation or named charity.

Recent developments

The §7520 rate environment significantly affects CRT economics — higher §7520 rates produce larger present-value remainder calculations and easier 10% test compliance. Rate increases through 2023 and 2024 made CRT structures more efficient than in the prior decade's low-rate environment.

Beneficiary-residency state taxation of CRT income post-Kaestner continues to develop; non-grantor CRTs sited in favorable states (South Dakota, Nevada) may avoid state income tax on undistributed income, with state tax due only on distribution receipt by the beneficiary.

Reviewed May 2026