Although a work of fine art can provide many benefits to our spirit and soul, it is still a tangible object that costs money to purchase and generates no income while owning it. The art can be sold, but the former owner must pay a 28% capital gains tax to the IRS, plus a 12% capital gains tax for New York state residents, plus a 3.8% federal surcharge for high-income individuals and couples, minus the state income tax deduction on the taxpayer’s federal return, for a net combined tax rate of about 41%. A growing number of art and collectibles owners are discovering that one way to earn income from their art while deferring capital gains taxes is through a charitable remainder joint trust.
Somewhat unsightly, a CRUT is a charitable remainder joint trust that allows collectors to transfer tangible items such as art to the trust and authorizes the trustee to sell the art when the market appears to be at a high. Proceeds from the sale become tax deferred, and the funds can be reinvested within the trust, growing over time. If Collector X owned a painting worth $1 million and sold it outright, that person would pay a 41% tax and be left with $590,000. However, if Collector
Once sold, a portion of the proceeds (from 5% to 50%, but usually 5% to 8%) is distributed annually to the beneficiaries, usually the donor and his or her spouse. Although some CRUTs are designed to last a specified number of years, most charitable remainder joint trusts end upon the death of the last beneficiary and the remaining funds become a gift to the designated charity.
“It’s a tax deferral strategy,” Lawton Leung, a trusts and estates partner at law firm Withers, told the Observer. Charitable trusts are considered tax-exempt entities. “Assuming you fund a CRUT with art, regardless of the type of appreciating property, the trust can sell it without tax implications. When an annuity or single trust payment is distributed, taxes will apply. Therefore, the donor or grantor of the trust will have to pay taxes on that note—the income he or she receives from the trust each year. The trust’s payments may be made quarterly, annually, semiannually, 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 in that assets can be reinvested and grow on a tax-deferred basis. “We particularly like using charitable remainder trusts when there is an opportunity to defer large capital gains,” says Liang.
He noted that CRUT offers collectors a way to take advantage of today’s art prices in a tax-efficient manner, generate income for retirement and achieve philanthropic goals. “The charity must receive at least 10% of the actuarial value when the trust is set up. The amount donated to the charity at the end of the term may vary. There is some unpredictability in the amount actually received by the charity, but at least at the start of the trust the charity is expected to receive at least 10% of the contribution.”
Collectors can reduce capital gains and estate taxes, but it’s not exactly a win-win. Once they put the art into a CRUT, they can’t keep it in their home or office—the rules governing remainder trusts are similar to those for individuals setting up private foundations—so most people keep their art somewhere else. This might be at a bank, a law firm or a willing art gallery; many collectors choose art storage facilities. Once an artwork is donated to a charitable remainder trust, it remains there; the collector cannot change his or her mind and take it back.
Charitable remainder trusts are typically not created in isolation but as part of a broader estate planning strategy for individuals with a range of valuable assets. However, Leung said the typical cost to set up a CRUT is $10,000. The first step is for the donor to irrevocably transfer the artwork or other personal assets to a trustee, usually a lawyer or banker. IRS actuarial tables calculate the amount the beneficiary is expected to receive over the life of the CRUT and the amount that will be donated to one or more designated charities based on the beneficiary’s age, payment percentage, and interest rate. The donor then deducts a calculated percentage of the donation to the charity when the trust was created, based on the item’s original cost rather than its current fair market value. The deduction may be spread over five years. For example, if the IRS actuarial tables indicate that 70% of the trust assets will go to the beneficiary and the remaining 30% to the charity, the donor will be entitled to deduct 30% of the cost of the assets. A painting purchased for $100,000 and transferred to CRUT would entitle the donor to a deduction of $30,000.
Each year the trustee sells the art, the individual beneficiaries typically receive a fixed percentage of the annual value of the trust assets. If a painting in the CRUT generates $1,000,000 in net income and the payout percentage is set at 5%, the beneficiary will receive $50,000 in the first year of the trust. These distributions are known as single trust payments, and the beneficiary is taxable in the year of the distribution based on the beneficiary’s overall income and how the trust income is invested. Meanwhile, the assets remaining in the CRUT continue to earn income and realize capital gains, with no immediate tax costs to the trust or beneficiaries. Therefore, annual single trust payments may increase by 5% over time as trust assets appreciate on a tax-deferred basis. The recipient receives an upfront tax credit and pays the tax when the annuity is received.
There is more than one type of charitable remainder trust. A charitable remainder annuity trust provides a scheduled payment to the recipient each year, whereas a unitary trust may pay a different amount each year based on the trust’s performance.
Typically, those considering CRUT are planning for retirement, a stage of life when they want to maximize income and minimize costs. Long-term art collectors may own highly appreciating assets that are expensive to store, secure and insure, and incur significant capital gains taxes if sold. People in this situation often want to simplify their lives by giving away some of their artistic assets, but they are unwilling to take on a huge tax bill in the process. A Charitable Remainder Joint Trust provides them with a steady stream of income and a smaller tax burden than they would face by selling assets outright, leaving more money for the charity or charities of their choice.
Although trust assets must be donated to charity, there is no requirement to designate a charity when the trust is created. People will change their minds about the charities they want to support, and that’s fine. Trustees may also name the charity.
