For all the good that a fine art piece may do for our spirits and souls, it remains a tangible object that costs money to buy and produces no income while it is owned. Artworks can be sold, but the former owner must then pay hefty capital gains taxes—28 percent to the IRS, plus 12 percent capital gains tax for New York State residents, plus a 3.8 percent federal surcharge for high-income individuals and couples, less the state income tax deduction on a taxpayer’s federal return, for a net combined tax rate of roughly 41 percent. One way a growing number of art and collectibles owners have found to earn income from their art while deferring capital gains taxes is through charitable remainder unitrusts.
Called, somewhat inelegantly, a CRUT, a charitable remainder unitrust allows collectors to transfer tangible objects such as art to a trust and authorize a trustee to sell the artwork when the market appears to be at a high point. The proceeds of the sale are tax-deferred, and the money can be reinvested to grow over time within the trust. If Collector X owns a $1 million painting and sells it outright, that person will pay the 41 percent tax and be left with $590,000. If, however, Collector X places the painting in a CRUT and then sells it, that person will have the full $1 million working for him and will pay capital gains on a deferred basis.
Once a sale occurs, a portion of the proceeds—ranging from five to 50 percent but typically 5-8 percent—will be distributed annually to the beneficiaries, usually the donor and their spouse. Although some CRUTs are designed to last a specified number of years, most charitable remainder unitrusts end at the death of the last individual beneficiary, and the remaining funds become gifts to designated charities.
“This is a tax deferral strategy,” Lawton Leung, a trust and estates partner in the law firm Withers, told Observer. The charitable trust is considered a tax-exempt entity. “Let’s say you’re funding that CRUT with artwork, whatever type of appreciated property, the trust can sell it without a tax hit. The tax would apply when there’s a distribution of the annuity or the unitrust payment. So then the donor or the grantor of the trust will have to pay taxes on that sliver—what he or she gets from the trust every year. The payments from the trust may be made quarterly, annually, biannually or monthly. It depends on the type of frequency you want, but at least once a year.”
The trust functions much like a 401(k) or IRA, as the assets can be reinvested and grow on a tax-deferred basis. “We particularly like to use charitable remainder trusts when there’s an opportunity to defer a large capital gain,” Leung said.
He noted that CRUTs offer collectors a way to take advantage of today’s art prices in a tax-efficient manner, generate income for retirement and satisfy philanthropic objectives. “The charity has to receive at least a 10 percent actuarial value at the time of setting up the trust. The amount that goes to charity at the end of the term could vary. There is some unpredictability to what the charity actually gets, but at least at the start of the trust, it’s intended that the charity would receive at least 10 percent of what was put in.”
Collectors can reduce their capital gains and estate taxes, but it isn’t entirely win-win. Once they place works of art in a CRUT, they cannot keep them in their homes or offices—the rules governing remainder trusts are similar to those for individuals setting up private foundations—so most keep the art elsewhere. That may be at a bank, a law firm or an art gallery willing to hold it; many collectors choose fine art storage facilities. Once an artwork has been donated to the charitable remainder trust, it stays there; the collector cannot change his mind and take it back.
Charitable remainder trusts are typically not created in isolation but rather as part of a broader estate planning strategy for individuals with a range of valuable assets. Still, Leung said, the typical cost of setting up a CRUT is $10,000. The first step is for the donor to transfer art or other personal assets irrevocably to the trustee, usually a lawyer or banker. An IRS actuarial table calculates, based on the age of the beneficiaries, the percentage payout rate and an interest rate, both the amount the beneficiaries are expected to receive over the lifetime of the CRUT and the amount that will go to one or more designated charities. The donor then deducts the calculated percentage gift to the charities at the time the trust is created, based on the original cost of the objects rather than their current fair market value. That deduction may be spread out over five years. For example, if the IRS actuarial table indicates that 70 percent of the trust’s assets will go to the beneficiaries and the remaining 30 percent to a charity, the donor would be entitled to deduct 30 percent of the cost of the assets. A painting purchased for $100,000 and transferred to a CRUT would entitle the donor to a $30,000 deduction.
Every year after the trustee sells the art, the individual beneficiaries will typically receive a fixed percentage of the annual value of the trust assets. If a painting in a CRUT generates $1,000,000 in net proceeds and the payout percentage is set at five percent, the beneficiary will receive $50,000 in the first year of the trust. These distributions, known as unitrust payments, are taxable to the beneficiary in the year they are made, based on the beneficiary’s overall income and the manner in which trust income has been invested. Meanwhile, assets remaining in the CRUT continue to earn income and realize capital gains without immediate tax cost to the trust or the beneficiary. As a result, five percent annual unitrust payments may grow over time as trust assets appreciate on a tax-deferred basis. The collector receives an upfront tax deduction and pays taxes as they receive annuity payments.
There is more than one type of charitable remainder trust. A charitable remainder annuity trust provides the collector with a predetermined payment each year, while a unitrust may pay out varying amounts annually depending on the trust’s performance.
Frequently, those considering a CRUT are planning for retirement, a period in life when they want to maximize income and minimize costs. Long-time art collectors may hold highly appreciated assets that carry high costs for storage, security and insurance and would generate large capital gains taxes if sold. People in that situation often want to simplify their lives by shedding some of their art assets, but they prefer not to incur a large tax bill in the process. A charitable remainder unitrust provides them with a stream of income and a smaller tax burden than they would face if they sold the assets outright, preserving more of their money for one or more charities of their choice.
While trust assets must go to charity, there is no requirement that the charity be designated when the trust is created. People change their minds about which charities they want to support, and that’s fine. The trustee may also name the charity.
Daniel Grant
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