From Tax-Loss Harvesting to a Charitable Remainder Unitrust
Loss harvesting manages the timing of tax on a concentrated position. A charitable remainder unitrust changes the economics: diversification without an immediate tax, a lifetime income stream, a current deduction and a charitable legacy.
Investors with large unrealized gains are paying more attention to tax aware portfolio strategies. Direct indexing, tax loss harvesting and long short tax aware accounts can all generate losses that offset gains elsewhere in the portfolio. These tools are useful, especially for investors with concentrated public stock, executive equity or a liquidity event on the horizon.
They are not magic. Loss harvesting strategies can involve higher fees, leverage, tracking error, borrowing costs, short sale complexity and future embedded gains, and the wash sale rules limit how quickly a sold position can be repurchased.1 In most cases they manage the timing of tax rather than change the underlying economics. For the right client there is a technique that does change the economics: a charitable remainder unitrust.
How a CRUT works
The donor contributes appreciated assets to an irrevocable trust. The trust pays the donor, or the donor and spouse, a fixed percentage of the trust's value, revalued each year, for life or for a term of up to twenty years, and whatever remains at the end passes to charity. The payout must be at least 5 percent and no more than 50 percent, and the present value of the charity's remainder interest must be at least 10 percent of what was contributed.2
The trust itself is exempt from income tax, so it can sell the concentrated position and diversify without paying capital gains tax at the time of sale.3 The donor pays tax only as the annual payments arrive, and each payment carries out the trust's income in a fixed order: ordinary income first, then capital gain, then tax exempt income, then return of principal.4 In practice a trust funded with low basis stock pays out capital gain for many years, taxed at capital gain rates, spread over the donor's lifetime.
What the donor gets
- Diversification of a low basis position without an immediate capital gains tax.
- A lifetime income stream for one or two lives, which rises if the trust grows.
- An income tax deduction in the year of funding equal to the present value of the charity's remainder interest, computed with the Service's monthly rate, subject to the percentage of income limits and a five year carryforward.5
- Removal of the contributed assets from the taxable estate, with a full estate tax deduction for the remainder and a marital deduction for a surviving spouse's interest.6
- A meaningful charitable legacy, which can go to a donor advised fund or private foundation the family directs.
An example
Spouses contribute $1 million of low basis concentrated stock to a unitrust paying 5 percent for their joint lives. They receive an immediate deduction for the actuarial value of the remainder, roughly $50,000 in the first year and a share of the trust's growth thereafter, and the stock is sold and diversified inside the trust without a current tax. If the trust assets grow meaningfully over the years, the charity may ultimately receive far more than the original contribution, and the couple will have received far more in payments than the tax they deferred.
Who it suits
A unitrust is especially compelling for business owners approaching a sale, retirees with concentrated stock, executives with low basis equity and charitably inclined investors who want both income and impact. It does not suit a client with no charitable intent, because the remainder really does go to charity, or a client who needs the full principal back.
The real point is not deferral. It is converting a concentrated, tax sensitive asset into a coordinated plan for income, diversification, philanthropy and legacy. For the right client, a CRUT is a tax smart exit, a retirement income strategy and a legacy plan in one instrument.
Notes
- I.R.C. section 1091. ↩
- I.R.C. section 664(d)(2). ↩
- I.R.C. section 664(c)(1). The exemption is lost for any year in which the trust has unrelated business taxable income, which is subject to a 100 percent excise tax under section 664(c)(2). ↩
- I.R.C. section 664(b). ↩
- I.R.C. sections 170(f)(2)(A), 170(b)(1)(C) and 7520. ↩
- I.R.C. sections 2055(e)(2)(A) and 2056(b)(8). ↩
Terry L. (T. L.) Turnipseed, J.D., LL.M., CTFA, is a tax, trust and estate attorney in Fort Lauderdale, Florida, and Head of Estate and Tax Planning at Alta Trust Company. He is a former tenured professor of law at Syracuse University. Reach him at tl@turnipseed.law or on LinkedIn. This article is general information, not legal advice.