Tax-Exempt Trusts

The bull market in stocks and real estate has created tremendous wealth for millions of investors.  It has also created an enormous capital gains tax problem, as investors attempt to sell, exchange, cash out, or otherwise realize the paper profits they have earned on their investment portfolio.

Financial planners, tax attorneys, and local charities recognize this tax problem, and offer seminars and educational material on tax and estate planning strategies using charitable remainder trusts and private annuity trusts.  These trusts can seem quite intimidating to the uninitiated.

Most of us are already familiar with tax-exempt trusts.  An Individual Retirement Account, for example, is a type of tax-exempt trust.  Ordinary income contributed to an IRA is exempt from ordinary income tax.  Funds within the IRA are invested and compound tax-free.  The "trust" funds are only taxed upon distribution from the trust to the beneficiary.

An IRA is a tax-exempt trust for ordinary income.  A charitable remainder trust, and a private annuity trust, are two tax-exempt trusts for capital gains income.  They operate under somewhat different rules, but the principles are the same.

Early planning is critical.  The IRS has strict rules and time limits.  Know your options before you list your property.

A Charitable Remainder Trust is appropriate for the investor who wishes to cash out of stocks, real estate, or any other appreciated asset, and defer taxes on the sale.  The trust must hold title to the property at the time of sale to avoid all taxes.

Similar to an IRA, a charitable remainder trust (CRT) defers tax on the sale of the asset, as well as on the earnings from the invested proceeds of the sale.  The trust will distribute an income stream to the beneficiaries, either for a term of years, or for the lifetime of the beneficiaries.  Upon termination, the remainder left in the trust must be contributed to a non-for-profit organization.  The investor will receive an charitable income tax deduction today, for a charitable gift that may not be made for decades.

A CRT is a highly dynamic tool.  The income stream, charitable gift, and resultant income tax deduction, are all variables that can be customized according to the investor's needs and goals. 

A Private Annuity Trust is conceptually similar, except there is no charitable gift, and no charitable deduction.  The trust "buys" the property from the investor, with a private lifetime annuity contract, valued at the property's fair market value.  The trust then sells the property in the market at fair market value, incurring no capital gain, and thus owes no capital gains tax. 

Advantages

• A technique to transfer property within the family, free of estate and gift tax, in exchange for a lifetime income
• The family controls the trust and the money.
• The trust can make a cash sale under optimal market conditions, and avoid taxes.
• Taxes are deferred on the sale of the property, and also on the compounded earnings on the proceeds within the trust.