You transfer an appreciated asset into the CRT. The trust sells the asset without paying immediate capital gains tax — because the trust is a tax-exempt entity. The trust reinvests the full proceeds and pays you an income stream for life or a term of years. At the end of the trust term (or at your death), the remaining assets pass to your designated charity. You receive a partial charitable deduction in the year of funding based on the actuarial present value of the charity's remainder interest.
Transfer appreciated asset into the CRT
You irrevocably transfer an appreciated asset — real estate, concentrated stock, a business interest — into the charitable remainder trust. The transfer is irrevocable. You receive a partial charitable income tax deduction based on the IRS-calculated present value of the charity's future remainder interest.
Trust sells the asset — no immediate capital gains
The CRT, as a tax-exempt entity, sells the transferred asset. Because the trust is tax-exempt, no capital gains tax is owed at the time of sale. The full proceeds are reinvested inside the trust — a significant advantage over a direct sale where you would owe capital gains immediately on the appreciation.
Trust pays you income for life or a fixed term
The trust distributes income to you — either a fixed annuity amount (CRAT) or a fixed percentage of the annual trust value (CRUT) — for your lifetime or a term up to 20 years. These distributions are taxable to you as they are received, using a four-tier ordering system: ordinary income first, then capital gains, then tax-free income, then return of principal.
Remainder passes to charity at termination
At the end of the trust term or at your death, the remaining trust assets pass to your designated charity or charities. The charity receives the remainder completely free of estate tax. If the charity is a donor-advised fund, a private foundation, or a community foundation, you retain flexibility over how the charitable remainder is ultimately used.
| Factor | CRAT — Charitable Remainder Annuity Trust | CRUT — Charitable Remainder Unitrust |
|---|---|---|
| Income payment | Fixed dollar amount — set at funding, never changes | Fixed percentage of trust value — recalculated annually |
| Additional contributions | No — cannot add assets after funding | ✓ Yes — additional contributions allowed |
| Inflation protection | None — fixed payment erodes with inflation | ✓ Yes — payment grows if trust value grows |
| Market risk to donor | Lower — payment is fixed regardless of performance | Higher — payment decreases if trust value falls |
| Minimum payout rate | 5% of initial fair market value | 5% of annual fair market value |
| Best for | Donors wanting predictable fixed income | ✓ Most donors — flexibility and inflation protection |
Tax treatment of CRT distributions — the four-tier system
Tier 1 — Ordinary income: Distributions are first characterized as ordinary income to the extent the trust has current or accumulated ordinary income (interest, dividends). Taxed at ordinary rates.
Tier 2 — Capital gains: Once ordinary income is exhausted, distributions are characterized as capital gains — long-term or short-term — to the extent the trust has capital gains from the sale of the original asset. Taxed at capital gains rates (0%, 15%, or 20%).
Tier 3 — Tax-exempt income: If the trust has tax-exempt income, it passes through as tax-exempt to the recipient.
Tier 4 — Return of principal: Only after all income categories are exhausted are distributions treated as a tax-free return of principal.
CRT + life insurance replacement strategy
A common concern with CRTs: by donating the asset to charity, you are reducing your heirs' inheritance. The solution is a wealth replacement trust — using a portion of the income tax savings and CRT income distributions to fund a life insurance policy (often inside an ILIT) that replaces the asset value for your heirs. The result: you receive a charitable deduction, avoid immediate capital gains, receive lifetime income, your heirs receive a tax-free life insurance death benefit, and charity receives the remainder. All parties benefit.