Frank Murphy Attorney and CPA

Pay lower income taxes AND avoid paying capital gains taxes?

Did you know that a charitable remainder trust can allow you to both reduce your income taxes, and avoid paying capital gains taxes on assets that have gone up in value? It is true, and not out of the “goodness of the IRS’s heart:” the laws passed by Congress have for many years allowed such trusts.

How does it work?

A client contributes property to a specially drafted charitable remainder trust. The client keeps the income on the trust assets for life. Assets can be contributed to the trust that have gone up in value. The bottom line is:

The assets contributed to the trust can be sold with no immediate capital gains taxes.

The client can reduce their income taxes by a charitable deduction for the value of the estimated remainder to charity (after the client or clients pass away, as the clients reserve the income on the assets).

The client may enjoy a higher level of income after selling the assets and avoiding the capital gains, as the money that would have been used pay the capital gains taxes can be invested within the charitable remainder trust to generate a higher amount of income for the client.

Is there any catch?

Yes, the catch is that after the client’s death the remainder of the assets in the charitable remainder trust must be distributed to charities. If the clients want the assets to go to their children there may be a small percentage going to charity instead.

However, the amount “diverted” to charity is NOT the total amount contributed to the charitable remainder trust. Remember that the client saves money on the reduced income taxes paid, AND in avoiding capital gains taxes. Thus a large portion of what is given to the charity in the remainder interest (at the client’s death) is recouped by saved income taxes and capital gains taxes.

A second “catch” is that congress has created limits for this loophole. The limits are a percentage of your adjusted gross income, so only a portion of your income tax bill can be offset. However, there is no limit to the savings by not paying capital gains taxes.

Who might consider a charitable trust as an estate planning strategy?

A. Clients with assets with substantial increases in value (that could generate capital gains).
B. Clients paying income taxes, that would like to reduce their income tax bill with deductions.
C. Clients with intent to benefit charity, but who want to retain the use of the assets during their own lifetime.