Morningstar Magazine - October/November 2017 - 53

Investments
From a fiduciary standpoint, CRT investments
must consider the fact that there are two
beneficiaries: the income beneficiary and the
remainder beneficiary. Thus, investments
can't be managed solely to produce income, nor
can they be managed solely for appreciation.
A typical investment allocation for a CRT is 60%
equities/40% fixed income.
Tax Consequences
The initial funding of a CRT, because it is
irrevocable, is considered a gift of two separate
interests: the income interest and the
remainder interest. If the donor retains the income
interest, then that portion is not a gift. However,
if the income interest is transferred to anyone
other than the donor, the value of that portion is
a reportable gift. The value of the remainder
interest is a charitable gift.

The IRS has a prescribed methodology for valuing
the income interest versus the remainder
interest. Essentially, the net present value of the
income stream is subtracted from the initial
valuation to determine the net present value of
the remainder interest.
To qualify under IRS rules, the charitable remainder
interest must be at least 10%.
For example, if under the above scenario,
Bob is age 60 at the formation of the CRT, the
value of the income interest would be
about $764,000 and the remainder interest would
be valued at about $236,000. Because
the remainder interest is greater than 10%, the
CRT would qualify for tax purposes and
$236,000 would be immediately deductible as
a charitable contribution.
When donating securities or other property to a
CRT, the full fair market value is taken into
account for calculating the charitable remainder
interest-even if the cost basis is lower.
Additionally, the built-in appreciation is not taxed.
This creates a double benefit when contributing
appreciated property:
3 The donor receives a tax deduction based on full
fair market value.

3 The donor does not pay tax on the
built-in appreciation.

Each year, the income beneficiary will report
taxable income from CRT distributions. This
income will be reported in priority order as follows:
3 Income generated in the trust, including ordinary
income and realized gains.
3 Unrealized capital gains from initial contributions.
3 Return of capital (basis).
Strategy
A CRT should be considered when two or more
of the following situations exist:
3 Need for annual tax-advantaged income.
3 High tax bracket.
3 Highly appreciated securities or other property.
3 Charitable intent.

Let's consider Matt's circumstances. Matt is
60 years old and owns a 10% interest in a biotech
company that is in the process of negotiating a
sale to a large publicly held company. He believes
the company will sell for $15 million. His cost
basis in the stock is negligible. We will assume
that Matt's combined federal and state
ordinary tax rate is 45% and his combined capital
gain rate is 25%.

from his CRT, or a total of $71,625. This is $15,375
(27%) more per year than if he simply sold all
of his stock.
Note that although his income stream increases,
Matt has irrevocably given up principle of
$630,000 ($750,000 put into CRT less tax savings of
$120,000). However, Matt is happy with greater
cash flow and knowing that his favorite charity will
receive money after his lifetime.
Doing Right
Advisors should consider suggesting a CRT
whenever a client desires annual cash
flow, has highly appreciated assets, is interested
in charitable giving, or is in a high tax
bracket. Advisors will not only be doing right by
their client, but they also will be facilitating an
eventual gift to a good cause. Of course, advisors
and their clients should always work with a
qualified attorney to ensure that all legal and tax
requirements are met. K
Sheryl Rowling, CPA/RFS is principal of Rowling & Associates
and head of rebalancing solutions with Morningstar.

If Matt sells all of his stock for $1.5 million, his tax
bill will be $375,000. He will have $1,125,000
remaining, which will be available for investment.
If Matt wants to take a "safe" withdrawal
rate of 5% per year, his annual pretax cash flow
from the investment will be about $56,250.
Alternatively, let's say that Matt puts 50% of his
stock into a CRT, paying out at 5% per year,
and that the appraised value at time of
contribution is $700,000. Matt will get a charitable
deduction of approximately $267,000, which
will reduce his tax bill by about $120,000. He will
also pay capital gain tax of $187,500 on
the remaining $750,000 sold. Thus, his personal
investment pool will be $682,500 ($750,000
sales proceeds less $187,500 capital gain tax plus
$120,000 tax savings). Assuming stable 5%
returns, Matt's annual cash flow at 5% will be
$34,125 from his investments plus $37,500

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