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. Appreciated assets contributed to the trust can be sold inside it without current income tax — spreading the gain, which keeps its character, across years of distributions — in exchange for a partial charitable 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% and no more than 50% of the initial net fair market value) paid at least annually for a term of years (up to 20) or for the life or lives of individual beneficiaries.
• CRUT (Charitable Remainder Unitrust) — a fixed percentage (at least 5% and no more than 50%) of trust assets, revalued annually, for the same permitted terms.

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 property; the trust can sell without current income tax because a CRT is exempt from income tax under §664(c) (other than the excise on unrelated business taxable income). The gain is not eliminated: it is carried in the trust's capital-gain tier and taxed to the beneficiaries as distributions are made, keeping its character (28% for collectibles gain).
• Partial charitable deduction. The donor receives an income-tax charitable deduction for the present value of the remainder interest, computed using the §7520 rate and the trust's payout terms. For tangible personal property such as art, the deduction is deferred until the trust sells the item (§170(a)(3)) and, because a sale is an unrelated use, is generally limited to the present value of the remainder computed on the donor's basis, not fair market value.
• Estate-tax removal. The remainder passes to charity; where the donor retains a lifetime interest the trust is included in the gross estate but offset by the estate-tax charitable deduction for the remainder (§2055), and the contributed assets' appreciation does not pass to heirs.

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 payout of 50% (added by the Taxpayer Relief Act of 1997).
• 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 (Rev. Rul. 77-374): the probability that the trust will be exhausted before the charity takes must not exceed 5%; Rev. Proc. 2016-42 provides a sample early-termination provision that avoids the test.
• 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. Procs. 2003-53 through 2003-60 (sample CRAT forms); Rev. Procs. 2005-52 through 2005-59 (sample CRUT forms).
• Rev. Rul. 77-374 (5%-probability test); Rev. Proc. 2016-42 (sample provision avoiding the test).
• Estate of Atkinson v. Commissioner, 309 F.3d 1290 (11th Cir. 2002) (CRAT that failed to make required annuity payments during the donor's life did not function as a CRT; estate charitable deduction denied).

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). At high payout rates or with young annuitants, CRATs can fail the Rev. Rul. 77-374 test; the Rev. Proc. 2016-42 early-termination provision is the usual cure. Operational failures (such as not paying the annuity) can also disqualify the trust, as in Atkinson.
• UBTI in the trust. Income from a trade or business or debt-financed property within the CRT can produce unrelated business taxable income. Before 2007 any UBTI caused the trust to lose its tax exemption for that year; for taxable years beginning after 2006, §664(c)(2) instead imposes a 100% excise tax on the UBTI.
• Self-dealing. The §4941 private-foundation self-dealing rules apply to CRTs through §4947(a)(2).
• 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 the trust defers the 28% collectibles tax (the gain is taxed to the donor as it is distributed); the deduction is basis-limited and deferred until sale; trust pays the unitrust amount to the donor; remainder funds a family foundation or named charity.

Recent developments

The §7520 rate environment matters most for CRATs: higher rates produce a larger remainder value, making the 10% remainder and 5%-probability tests easier to satisfy. For CRUTs, the §7520 rate has comparatively little effect on the deduction. The higher rates of 2023 onward made CRATs considerably more workable than in the low-rate decade before.

State treatment of CRTs varies: most states follow the federal exemption at the trust level and tax beneficiaries on distributions under their own residence rules. From 2026 the One Big Beautiful Bill Act imposes a 0.5%-of-AGI floor on itemized charitable deductions and caps the tax value of itemized deductions at 35% for top-bracket taxpayers, modestly reducing the value of the remainder deduction.

Reviewed October 2026