Charitable remainder trust rules come from Internal Revenue Code Section 664 and a handful of related provisions that together dictate how the trust must be structured, how much it can pay you, who can receive what’s left, how your payments are taxed, and what has to be filed each year. Get any of the structural requirements wrong and the trust loses its tax-exempt status, meaning every dollar of income it earns becomes taxable.1Internal Revenue Service. Self-Dealing and Other Tax Issues Involving Charitable Remainder Unitrusts The rules below are the ones that decide whether a CRT works as intended.
Annuity Trust or Unitrust: You Have to Pick One
The IRS recognizes two CRT structures, and the choice locks in how your payments behave for the life of the trust.
A charitable remainder annuity trust (CRAT) pays a fixed dollar amount every year, set when the trust is created as a percentage of the initial fair market value of the contributed assets. That percentage must fall between 5% and 50%.2Internal Revenue Service. Charitable Remainder Trusts Because the annuity is calculated on the initial value, no additional contributions are allowed after the trust is funded.3Office of the Law Revision Counsel. 26 USC 664 Charitable Remainder Trusts
A charitable remainder unitrust (CRUT) pays a fixed percentage (again 5% to 50%) of the trust’s assets, revalued every year. Your payment rises in good years and falls in bad ones. You can make additional contributions to a CRUT after the initial funding.2Internal Revenue Service. Charitable Remainder Trusts CRUTs come in several variations for illiquid assets, including net-income versions (NICRUT and NIMCRUT) that cap payments at the trust’s actual earnings, and a Flip CRUT that starts as a NIMCRUT and permanently converts to a standard CRUT after a triggering event such as the sale of a hard-to-value asset.
The Section 664 Qualification Tests
Calling something a CRT doesn’t make it one. The trust document has to satisfy every structural requirement in Section 664, and the trust must operate as a CRT from day one.1Internal Revenue Service. Self-Dealing and Other Tax Issues Involving Charitable Remainder Unitrusts
Payout Rate and Term
The annual payment to the income beneficiary must be at least 5% and no more than 50% of the relevant asset value, and payments must be made at least once a year.3Office of the Law Revision Counsel. 26 USC 664 Charitable Remainder Trusts The trust term can run either for the lifetime of one or more individuals who are alive when the trust is created, or for a fixed period of no more than 20 years.2Internal Revenue Service. Charitable Remainder Trusts You can’t combine the two and say “20 years or life, whichever is longer.”
The 10% Remainder Test
At funding, the present value of the charity’s projected remainder interest must equal at least 10% of the net fair market value of what you contributed.2Internal Revenue Service. Charitable Remainder Trusts The calculation uses the Section 7520 rate for the funding month, which is 120% of the federal midterm rate rounded to the nearest two-tenths of a percent.4Internal Revenue Service. Section 7520 Interest Rates
This test caps how aggressive you can be. Combining a high payout rate with a young lifetime beneficiary can easily push the projected remainder below 10%, because the trust is expected to distribute so much over so many years that the charity’s slice becomes too small. Well-drafted trust documents include language that adjusts the payout or term if needed to meet the threshold.
The 5% Probability-of-Exhaustion Test for CRATs
CRATs face an extra hurdle. Under Revenue Ruling 77-374, if there’s a 5% or greater probability that the trust will run out of assets before the term ends, the IRS denies the charitable deduction entirely. The risk arises when the fixed annuity exceeds the trust’s assumed earning rate under the Section 7520 rate, and it compounds each year the annuity has to invade principal.
Revenue Procedure 2016-42 offers a workaround. Including specific language that terminates the CRAT and distributes the remaining assets to charity if the corpus ever falls to 10% of its initial value lets the trust bypass the 5% probability test.
The Upfront Deduction and AGI Limits
Funding a CRT produces an immediate income tax deduction, but only for the present value of the charity’s projected remainder interest, not for the full value of the contributed assets. The calculation depends on the payout rate, the trust term or the beneficiary’s life expectancy, and the Section 7520 rate for the month of funding.4Internal Revenue Service. Section 7520 Interest Rates
How much of the deduction you can use in the funding year depends on what you contributed. Cash contributions are deductible up to 60% of your adjusted gross income. Appreciated long-term capital gain property is deductible up to 30% of AGI.5Office of the Law Revision Counsel. 26 US Code 170 – Charitable, Etc., Contributions and Gifts Any deduction that exceeds the applicable cap carries forward for up to five more tax years on a first-in, first-out basis.
How Your Distributions Are Taxed
The trust itself pays no income tax on its investment earnings, but you owe tax on what it pays out to you. Section 664(b) sets a strict four-tier ordering rule that runs from the most heavily taxed category down to tax-free return of principal.3Office of the Law Revision Counsel. 26 USC 664 Charitable Remainder Trusts
- Tier 1 is ordinary income (interest, non-qualified dividends, short-term gains) accumulated in the current and prior years, taxed at your ordinary rate.
- Tier 2 is long-term capital gains, taxed at preferential rates, but only once all accumulated ordinary income has been distributed.
- Tier 3 is other income, such as tax-exempt municipal bond interest, once tiers 1 and 2 are exhausted.
- Tier 4 is tax-free return of the corpus you contributed, reached only after every other tier has been distributed.
If a CRUT pays you $10,000 in a year when the trust has $3,000 of accumulated ordinary income and $5,000 of accumulated capital gains, the first $3,000 is ordinary income, the next $5,000 is long-term capital gain, and the last $2,000 is a tax-free return of corpus.
This ordering is why CRTs work so well for selling appreciated assets. When you contribute low-basis stock and the trustee sells it inside the trust, no tax is due at sale. The full pre-tax proceeds stay invested. The gain still exists on the trust’s books and reaches you eventually through the tier system, but the deferral means a larger sum keeps compounding.
What You Can and Can’t Put In
Highly appreciated, low-basis assets like publicly traded stock, real estate, and closely held business interests are the typical CRT contributions because the deferral of capital gains inside the trust is where the strategy earns its keep. Two categories cause problems.
S corporation stock cannot go into a CRT. A CRT is not a permitted S corporation shareholder, and transferring shares would blow the S election and turn the company into a C corporation. Retirement account assets (IRAs, 401(k)s) also can’t be contributed directly, because withdrawing from the retirement account triggers immediate income tax before anything reaches the trust.
For non-cash property worth more than $5,000, you need a qualified appraisal and must complete Section B of Form 8283 with your personal return for the year of the contribution.6Internal Revenue Service. Instructions for Form 8283 Publicly traded securities are generally exempt from the appraisal requirement. Real estate, closely held stock, and other hard-to-value assets need an independent appraisal performed no earlier than 60 days before the contribution and no later than the return’s due date. The trustee also has to obtain an EIN for the trust by filing Form SS-4.7Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN)
Self-Dealing Is Prohibited
CRTs are subject to the private foundation self-dealing rules under IRC Section 4941, applied through Section 4947(a)(2).8Internal Revenue Service. A General Explanation of Trusts Subject to IRC 4947 The donor, the trustee, family members, and related entities cannot transact with the trust beyond the normal distribution payments. No selling property to the trust, no buying property from it, no leasing space from it, no borrowing against its assets.
The IRS has specifically targeted arrangements that use CRTs to convert appreciated assets into cash while sheltering the gain through improper self-dealing.1Internal Revenue Service. Self-Dealing and Other Tax Issues Involving Charitable Remainder Unitrusts Violations trigger excise taxes on the disqualified person, and the penalties escalate quickly if the transaction isn’t corrected.
Annual Filings and Administration
Once the trust is running, the trustee has to value the assets annually, file with the IRS, and report to beneficiaries.
Every CRT files Form 5227, the Split-Interest Trust Information Return, each year. It reports the trust’s income, gains, expenses, and the four-tier characterization of distributions.9Internal Revenue Service. Split-Interest Trust Annual Return Form 5227 For a calendar-year trust, Form 5227 is due April 15 of the following year. If the trust terminates mid-year, the final return is due by the 15th day of the fourth month after the termination date.10Internal Revenue Service. 2025 Instructions for Form 5227
A separate Form 1041 is generally not required because the CRT is tax-exempt. But if the trust earns unrelated business taxable income in any year, it owes an excise tax equal to 100% of that UBTI.3Office of the Law Revision Counsel. 26 USC 664 Charitable Remainder Trusts The trust doesn’t lose its overall exemption over UBTI; the excise tax simply claws back the benefit on that particular income. UBTI usually comes from debt-financed property or active business operations, so most CRTs holding conventional portfolios never see it.
The trustee also issues a Schedule K-1 to each income beneficiary each year, breaking down the payments across all four tiers.2Internal Revenue Service. Charitable Remainder Trusts Beneficiaries use the K-1 to report CRT income on their personal returns, and accurate K-1s matter because the tier system determines whether each dollar is taxed as ordinary income, capital gain, or tax-free principal.
Ending the Trust Early
A CRT is irrevocable, but it can end before its stated term. With the charity’s consent, the trust can be terminated early by splitting the current assets between the income beneficiary and the charity based on the present value of their respective interests. Most early terminations also require consent from the state attorney general or a court with jurisdiction over the trust. An income beneficiary can also simply relinquish their income interest and assign it to the charity, which produces a current income tax deduction for the present value of the surrendered interest, calculated the same way as the original charitable deduction based on the stated payout percentage in the trust document.