How a Charitable Remainder Trust (CRT) Works — a practical guide

A Charitable Remainder Trust (CRT) is a tax-aware estate and philanthropic planning tool that converts appreciated property into a lifetime (or term) income stream while preserving a gift to charity. The concept is straightforward in principle but requires careful drafting, trustee selection, and tax calculation to deliver the intended benefits.

This guide explains how CRTs work, the two main CRT types, the tax mechanics, trustee and asset considerations, common pitfalls, and practical next steps. Where useful, I cite IRS guidance and link to related FinHelp resources for further reading.

Sources: IRS rules governing CRTs are primarily in Internal Revenue Code §664 and the IRS guidance on Charitable Remainder Trusts (see https://www.irs.gov/charities-non-profits/charitable-remainder-trusts). Present-value calculations rely on the IRS Section 7520 rate published monthly.

The basic flow

  1. Donor transfers assets (for example, appreciated stock or real estate) into a newly created irrevocable CRT. Because the CRT is tax-exempt for purposes of the sale, the trust can sell appreciated property without immediate recognition of capital gain.
  2. The trust invests sale proceeds and other assets and pays out an income stream to the named non-charitable beneficiaries (typically the donor and/or the donor’s spouse) for either the beneficiaries’ lifetime(s) or for a fixed term not exceeding 20 years.
  3. When the trust term ends, the remaining assets — the “remainder interest” — are distributed to one or more qualified public charities chosen in the trust document.

Types of CRTs and how payouts differ

  • Charitable Remainder Annuity Trust (CRAT): Pays a fixed dollar amount each year equal to a fixed percentage of the initial trust principal. The payment amount does not change even if asset values fluctuate.

  • Charitable Remainder Unitrust (CRUT): Pays a fixed percentage of the annual fair market value of the trust assets. Because payments are recalculated yearly, they can rise or fall with investment returns and valuations.

Variants of CRUTs include the Net Income CRUT (NICRUT), the NIMCRUT (Net Income with Makeup), and the flip CRUT (which switches from one payout method to another on a triggering event). Choice of vehicle affects income variability, tax treatment, and administrative complexity.

Key tax rules and benefits (what to expect)

  • Capital gains: When the CRT sells appreciated assets contributed to it, the trust generally recognizes no immediate capital gain; the tax burden is deferred and allocated to beneficiaries when they receive distributions, using the trust distribution tax tiers. This preserves full sale proceeds for reinvestment inside the trust.

  • Income tax deduction: The donor receives an immediate charitable income tax deduction for the present value of the remainder interest that will ultimately go to charity. The deduction is computed using actuarial tables and the IRS Section 7520 rate in effect for the month of the transfer. The deduction is limited by ordinary percentage limitations and carryforward rules under the tax code.

  • Estate tax: Because assets transferred to a CRT are removed from the donor’s estate, a properly structured trust can reduce estate tax exposure for high-net-worth individuals. (Estate-tax impact depends on current exemption amounts and your overall estate plan.)

  • Taxation of distributions: Distributions to income beneficiaries are taxed under a statutory ordering rule (tiers): first as ordinary income, then capital gains, then tax-free return of principal. Beneficiaries should expect taxable income from CRT distributions and plan accordingly.

Authoritative guidance: see IRS Charitable Remainder Trust page and IRC §664.

Qualification rules and limits you must know

  • Irrevocable: A CRT is generally irrevocable. You cannot revoke or materially change the charitable remainder once the trust is funded.

  • Minimum payout and remainder test: To qualify under §664, the trust must pay at least 5% of its value annually, and the actuarially computed remainder interest passing to charity generally must be at least 10% of the initial contribution. These tests protect the trust’s status as a charitable remainder vehicle.

  • Term limits: A CRT can pay income for the lifetime of one or more beneficiaries or for a term of up to 20 years.

  • Section 7520 rate: The charitable deduction and some valuation computations use the IRS Section 7520 rate published monthly; small changes in that rate materially affect the deductible remainder and payout planning.

  • Asset restrictions: Certain assets can create complications. For example, holding S-corporation stock inside a CRT is typically problematic because S corporations cannot have tax-exempt shareholders. Similarly, real estate that produces unrelated business taxable income (UBTI) or requires active management may create tax or operational issues for the trust. Work with counsel to review specific asset types.

Who should consider a CRT?

CRTs are most often recommended when all or most of the following are true:

  • You own highly appreciated, low-basis assets you do not wish to liquidate personally because of capital gains taxes.
  • You want an income stream during your lifetime (or for a set term) while also making a meaningful gift to charity.
  • You are comfortable making an irrevocable transfer and working with a trustee to manage investments and distributions.
  • You will benefit from a current-year charitable income tax deduction and possibly estate tax reduction.

CRTs are not ideal if you need flexible access to the principal, want to retain control of capital gains harvesting, or cannot accommodate the administration costs and trustee oversight CRTs require.

Practical example (simplified)

Suppose a donor owns stock bought for $100,000 that is now worth $500,000. Selling personally would trigger capital gains tax on the $400,000 gain. Instead, the donor transfers the stock to a CRT. The CRT sells the stock tax-free, reinvests $500,000, and pays the donor 5% per year ($25,000) for life or a fixed term. The donor receives an immediate charitable income tax deduction equal to the present value of the remainder interest (calculated using the Section 7520 rate). After the trust term, the remainder passes to the charity. The CRT preserved full sale proceeds for reinvestment and delayed taxation to the timing and character of distributions to the income beneficiary.

(Exact deduction amounts and tax consequences depend on the Section 7520 rate at transfer, the payout percentage, the beneficiary ages, and IRS rules. Consult a tax advisor for an illustration tailored to your facts.)

Trustee, administration, costs, and governance

Selecting the right trustee is critical. Trustees can be individuals, banks, or trust companies. Expect ongoing administrative duties: annual accounting, tax filings (Form 5227 and trust Form 1041 when applicable), investment management, and reporting to beneficiaries and charities. Professional trustees add objectivity and continuity but charge fees that reduce net returns. Balance cost, expertise, and trust complexity when choosing a trustee.

Common mistakes and pitfalls

  • Underestimating administrative costs and trustee fees.
  • Failing to model the tax and cash-flow implications across multiple scenarios (different Section 7520 rates and market returns).
  • Funding the CRT with inappropriate or illiquid assets without a clear exit strategy.
  • Overlooking special rules (e.g., S-corporation ownership issues) that can disqualify the trust or create unintended tax consequences.

How to proceed (practical next steps)

  1. Collect accurate basis and cost information for the asset(s) you are considering gifting.
  2. Request a Section 7520-sensitive illustration from a trust attorney or tax advisor that shows projected payouts, the charitable deduction, and after-tax cash flows under several market-rate scenarios.
  3. Discuss trustee options and fees; decide whether to use a professional corporate trustee or a trusted individual.
  4. Coordinate the CRT with your broader estate plan (wills, beneficiary designations, and other trusts).
  5. Review charitable recipients to ensure they are qualified public charities and that the trust’s remainder designation matches charitable intent.

FinHelp resources: For related strategies and comparisons, see our pieces on Using Charitable Remainder Trusts for Income and Impact and broader planning ideas in Tax-Efficient Charitable Giving Strategies. If you’re weighing alternative vehicles, our article on Charitable Lead Trusts: When They Make Sense explains when income-to-charity-first structures fit better than CRTs.

Bottom line

A Charitable Remainder Trust is a powerful option when you want to convert appreciated, hard-to-sell assets into an income stream while supporting charity and capturing tax benefits. The mechanics are governed by IRC §664 and IRS valuations under Section 7520. Because a CRT is irrevocable and technically complex, you should work with a qualified estate planning attorney and tax advisor to design, model, and fund the trust.

Professional disclaimer: This article is educational only and does not constitute legal, tax, or investment advice. Your situation is unique; consult a qualified attorney and tax advisor before creating or funding a Charitable Remainder Trust.

Authoritative sources