Last Week's Economic Data & Charitable Remainder UniTrusts
Updated: Sep 3
Charitable Remainder Unitrusts: Turning Highly Appreciated Assets Into Income
For investors who have accumulated significant wealth, one of the biggest financial planning problems can be what to do with an asset that has appreciated dramatically.
Maybe you bought a stock years ago for $50,000 and it is now worth $500,000. Maybe you own a highly appreciated piece of real estate, a concentrated position in a company, or an interest in a closely held business.
Selling the asset could create a massive capital gains tax bill.
But what if you want to diversify, generate income, and ultimately give some of your wealth to charity?
A Charitable Remainder Unitrust (CRUT) can be a powerful planning strategy worth considering.
The Basic Idea
A CRUT is an irrevocable trust that allows you to contribute assets to the trust, receive income from the trust for your lifetime or a specified period, and ultimately have the remaining assets pass to a qualified charity.
The key distinction is that a CRUT generally pays the beneficiary a percentage of the trust’s value, recalculated annually. The IRS generally requires the unitrust percentage to be at least 5% and no more than 50%, along with other requirements including a minimum 10% actuarial value for the charitable remainder interest.
That structure can be particularly interesting when the asset being contributed has a very low cost basis and a very high current value.
Why Appreciated Assets Are So Interesting
Consider a hypothetical investor who owns $1 million of stock with a $100,000 cost basis.
If they sell the stock outright, they could recognize approximately $900,000 of capital gain, before considering other tax factors.
Instead, they could potentially contribute the stock to a properly structured CRUT.
The trust generally carries over the donor’s basis, rather than receiving a step-up in basis simply because the asset was transferred to the trust.
The CRUT can then sell the appreciated investment and reinvest the proceeds into a diversified portfolio.
This is where the strategy gets interesting.
The CRUT generally isn’t subject to immediate income tax on the sale in the same way an individual investor would be. Instead, the tax consequences generally flow through to the beneficiary as distributions are made under the special ordering rules applicable to charitable remainder trusts.
The tax isn’t necessarily eliminated. It’s deferred and potentially spread over time.
That distinction is critical.
Creating an Income Stream
Suppose our hypothetical investor contributes $1 million of appreciated stock to a CRUT with a 5% unitrust payout.
If the trust were valued at $1 million, the initial annual unitrust payment would generally be approximately $50,000.
But because a CRUT is revalued annually, the payment can change.
If the trust grows to $1.2 million, a 5% payout would produce approximately $60,000.
If the trust declines to $800,000, the payment would generally fall to approximately $40,000.
This means a CRUT can provide an income stream while also allowing the remaining assets to stay invested. The IRS describes CRUT payments as being based on a fixed percentage of the trust’s assets, valued annually.
The Charitable Deduction
There can also be an income-tax charitable deduction when the CRUT is established.
However, you don’t simply deduct the entire value of the assets transferred to the trust.
The deduction generally represents the present value of the charitable remainder interest, subject to applicable tax rules and limitations.
The actual deduction depends on factors such as:
The value of the assets contributed
The payout percentage
The age of the beneficiaries
The term of the trust
Applicable IRS interest-rate assumptions
The projected value of the charitable remainder
This is why CRUT planning requires coordination between your financial advisor, CPA and estate-planning attorney.
An Example
Imagine a 65-year-old investor owns $2 million of highly appreciated stock.
Their cost basis is only $200,000.
They don’t necessarily need all of the money today, but they want to diversify their portfolio, generate retirement income and eventually leave money to charity.
A CRUT could potentially allow them to:
1. Transfer the appreciated stock to the CRUT
The transfer is irrevocable, meaning the assets cannot simply be taken back.
2. Have the CRUT sell the investment
The trust can sell the appreciated asset and reinvest the proceeds without the same immediate capital-gains recognition that an outright sale by the individual would produce.
3. Diversify the portfolio
Instead of continuing to hold one concentrated position, the proceeds could potentially be invested across a diversified portfolio.
4. Receive annual payments
The beneficiary receives the prescribed unitrust payments.
5. Potentially receive a charitable deduction
The donor may receive a deduction for the actuarial value of the charitable remainder, subject to the applicable rules.
6. Leave the remaining assets to charity
When the trust terminates, the remaining assets go to the designated charitable organization.
That combination can make a CRUT particularly compelling for someone who has highly appreciated assets, a desire for income, charitable intent and a need for diversification.
The Important Catch
A CRUT is not a magic tax loophole.
Once assets are transferred into the trust, the transfer is generally irrevocable. You are giving up ownership of the assets in exchange for the income interest and charitable structure.
And while the initial sale inside the trust can defer the immediate recognition of gain, distributions to beneficiaries are subject to the CRT’s tax-character ordering rules.
In other words:
Tax deferral is not the same thing as tax elimination.
There are also significant legal, administrative, valuation and tax-compliance requirements.
The IRS has specifically warned about abusive transactions attempting to use charitable remainder trusts to improperly eliminate capital gains or ordinary income.
That makes proper implementation extremely important.
Who Should Consider a CRUT?
A CRUT isn’t appropriate for everyone.
It may be worth exploring for someone who has:
Highly appreciated stock or real estate
A very low cost basis
A desire to diversify
A need or desire for retirement income
Significant charitable intentions
A long-term financial plan that can accommodate an irrevocable transfer
A sufficiently large asset to justify the legal and administrative complexity
The bigger the embedded gain and the stronger the charitable intent, the more interesting the conversation can become.
The Bigger Financial Planning Lesson
The most important part of CRUT planning isn’t the trust itself.
It’s recognizing that the tax consequences of selling an investment can be just as important as the investment’s rate of return.
Two investors can own the exact same $1 million asset and have dramatically different after-tax outcomes depending on how they sell, when they sell and what they do with the proceeds.
For highly appreciated assets, the question shouldn’t simply be:
“Should I sell?”
It should be:
“How can I restructure this asset in the most tax-efficient way while still accomplishing my investment, income, estate and charitable goals?”
A CRUT is one strategy that can potentially turn a highly appreciated asset into a diversified portfolio, an income stream and a charitable legacy—all within one financial planning strategy.
And for the right investor, that can be far more valuable than simply writing a check to the IRS after an outright sale.
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Colin Symons, CIO Lloyd Financial Group
We had some pretty interesting economic news, this week. What happened, exactly? Inflation prints were weak and retail sales were even weaker, which in theory could lead to fears the consumer is doomed.
The market is trying to look past this retail report. Even within the report, you can claim a lot of factors that could make this a one-off. For instance, non-store retail really drove the miss, which is probably due to the timing of Amazon Prime Day. Weak auto sales also hurt, and that’s a volatile number. Gas station sales fell as gas prices took a break. Seven of thirteen categories actually saw an increase, so this may be more noise than signal.
However, I do think it’s interesting that we have weak inflation and weak sales happening together. We also have the Personal Saving Rate nearer lows than highs as a sign the median consumer is running out of money. Additionally, since Amazon Prime Day was shifted to June, this year, shouldn’t we have seen an associated spike for that month, opposing the decline we saw for July? I’m going to be keeping a close eye on consumer data, as I’m not as convinced as the market that the consumer is OK.
If the market thought the consumer was in trouble, we’d start pricing in a recession by seeing a bid for long-term Treasuries, and instead the opposite is happening. We had two long-term Treasury auctions, last week. The auctions both had multi-decade high auction yields. It’s worth noting that this is at the long-end of the Treasury spectrum, not the short-end, where rates are somewhat calmer. Thus, it’s not about Fed policy. For the 10Y, the rate stopped at 4.683%, the highest since 2007. For the 30Y, the rate stopped at 5.216%, the highest since 2001! The auctions went fine, no sign of dysfunction; they’re just high rates. Why?
Breaking rates down into inflation expectations and real rates; this push has been about real rates growing, with inflation expectations having a minimal impact. I’d posit that’s largely due to big AI demand and expectations, which in turn has two effects. First, the large quantity of bonds sold drives up rates just because there’s so much supply. Second, AI is expected to grow productivity, helping to keep growth strong and rates relatively high.
When does it end? Presumably when AI growth (sale of bonds and expectations) slows.
Thus far, corporate issuance has been very high, with YTD investment grade issuance up 27% Y/Y. August has seen that trend continue, with $130B already issued, versus a seasonal average of about $95B for the whole month. The drive to fund AI has been very real, and this has likely been the main driver stressing long-term rates.
Fortunately, S&P Global and others expect we’ll see that push slow in coming months. We’re currently at a pace of 19% growth in debt and they expect we’ll slow to 12% for the whole year. That makes sense to me, as the rush to lock in financing for AI buildout should ebb. September to November traditionally sees active investment grade supply to lock in funding for year-end. The hope and expectation are that this seasonality effect has already happened, this year.
As we stand, we’re at high levels of real rates relative to history, as the chart above shows. Personally, I’d be willing to entertain the idea that the recent spike may be a euphoric top, and maybe long-term real rates are around long-term highs. Nobody really knows, of course. There’re no signs that real rates are going sharply down anytime soon. I’d expect the soonest we see a decent downtrend in real rates would be next year, at some point, but that’s speculation.
To recap, the market is unconcerned about a slowdown. I agree that it will take a lot of time to get from where we are now to a recession, but I disagree with the market’s dismissiveness and will be watching closely to see if consumer weakness continues. Strong AI bond demand seems like the biggest current concern. While that’s expected to at least fail to get worse, that also bears close watching. The market still looks good, but I think the need to monitor is now higher than it was, as the ability to get in substantive trouble is on the rise.
Pretty quiet start to what seems like a pretty quiet week. Economic news is pretty light for the week, with retail stock reporting highlighting the tail end of earnings reporting. VIXpiration on Wednesday and OpEx on Friday are also a focus, as they can change positioning.
Retail Sales were -0.6% m/m vs. exp. 0.1%, with Core Sales -0.3% vs. exp. 0.2% and the Control Group -0.4% vs. exp. 0.3%. That’s the first negative prince since March but a lot of that was a shift in Amazon Prime Day messing with timing.
Japan’s 10Y bond yields hit a 30Y high.
Trading company Jane Street lost about $15B as the Situational Awareness fund imploded in July, showing some of the collateral damage.
Empire Fed Manufacturing today.
Bottom line: Quiet start to the week as we prepare for VIX and options expirations, this week.
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