Getting More from a High-Value Illiquid Asset

Let’s say you’ve done well enough to have no worries about outliving your savings and investments. In fact, one of your investments has done so well that you have one of the ultimate first-world problems: you must either 1) sell the investment in your lifetime to diversify away from the exposure, triggering a big tax bill, or 2) leave it in your estate, leaving you unable to use the investment to cover retirement expenses during your life.

You might think, “I’ve worked hard, but I’ve also been lucky—I’d like some of my wealth to help others. But I’d like to do the choosing. A charity or some deserving family member.” A small voice in your head adds, “Maybe I can also get a tax break!”

This is all very doable. A charitable remainder trust, or CRT, gives you control over where that money goes by letting you make a generous gift to one or more charitable organizations and provide income to yourself or others. And you get a tax break up front.

With a CRT, you put one or more assets in an irrevocable trust. The income from the asset goes to whoever you’ve designated as beneficiary—yourself, or one or more other people—either over the beneficiary’s lifetime or for a specific period of time. (There are two kinds of CRT—CRUTs, or charitable remainder unitrusts, and CRATs, or charitable remainder annuity trusts—and they distribute income differently, but for this discussion, they operate similarly. For more, see our earlier Insight.)

At the end of the trust’s term, whatever assets are left over go to the charities you designate when you create the trust.

Big tax advantages

Qualified CRTs are usually exempt from federal income tax, making them useful for highly appreciated assets, which can be sold by the trustee with no capital gains taxes. Instead of capital gains taxes going to the government, the asset’s entire remaining value at the end of the trust’s term goes to your chosen charity.

The trust’s grantor—if you funded the trust, that’s you—gets an income tax deduction for the charitable donation equal to IRS’s estimated future value of the asset that will go to the charities at the end of the trust’s term. Funding a CRT also moves the value of the trust assets out of your estate, which may help save in estate taxes down the road.

So far so good. But let’s say the asset you want to donate is hard to sell. It’s either illiquid (real estate, a work of art, or a set of collectibles) or currently unmarketable (shares in a closely-held business).

Standard CRTs must pay out a certain amount of trust assets (income or principal) each year—income or principal. That can be difficult if not impossible if its assets don’t produce income or are illiquid.

There are two non-standard CRTs that offer some flexibility on whether, and how, beneficiaries get paid. These CRTs simply pay out the income produced each year to the beneficiary, but only are required to pay whatever income is produced. This is usually less than ideal for the grantor, who may want to receive more income when it’s needed in retirement or down the road, when the asset sells. (If you’re interested in these two non-standard trusts—the net income CRUT (NICRUT) or the net income makeup CRUT (NIMCRUT)—read more here.)

Having and Eating Your Cake: The Flip CRUT

A flip CRUT overcomes these limitations.

Flip CRUTs always start out as one of the non-standard CRUTs, which provide the flexibility of paying out the lesser of the trust’s actual income or a fixed percentage each year. Flip CRUTs then “flip,” or change into a standard CRUT, on a triggering event, which can be the sale of unmarketable assets—including the highly appreciated asset that gave you that first-world problem.

Flip CRUTs lend themselves to some pretty creative solutions.

Getting More Income in Retirement

As a grantor, your flip CRUT lets you use your highly appreciated or illiquid asset to help fund your retirement, with all the tax advantages mentioned above. Whether the trigger event is the year of your planned retirement or the age you expect to retire, the asset can continue to grow tax-free until then. At the flip, you will start receiving income from an asset that, ideally, has appreciated, became saleable, and was sold.

Income Upon Sale

Alternatively, you may want to flip to income once your illiquid asset becomes saleable or matures. For example, maybe the asset is a closely-held business and doesn’t produce income now. But once it’s sold, you want it to pay out income from the proceeds of the sale. The triggering event can be the sale of the asset.

Benefitting Survivors

Maybe you’d like to help out a family member or another person in need by providing the potential for higher income. In this case, the trigger event might be the death of a family member’s working spouse, a divorce, or the birth of a child. In this case, the flip CRUT becomes a safety net you set up for others.

Dealing with Uncertainty

You might also use a flip CRUT as a kind of insurance on income uncertainty—a contingency plan if you or someone else loses the capacity to produce income. Here, the triggering event could be the loss of a job or becoming disabled.

The flexibility to include marketable assets along with the unmarketable security in the flip CRUT provides more certainty that the trust will pay out, no matter what happens to the value of the unmarketable security.

Keep in mind that Flip CRUTs:

• Have a stable percentage payout that doesn’t change after the flip

• Are triggered by a specific date or event

• Always flip from a net income CRUT (NI-CRUT) or net income with makeup CRUT (NIMCRUT)

• Flip just one time only, on the first day of the year following the year the triggering event happens

• Forfeit any remaining make-up payments at the time of the flip (if it’s flipping from a NIMCRUT)

The triggering event must be beyond the control or discretion of anyone, including the donor, the trustee, and the non-charitable beneficiary. Triggering events can include:

• The sale of unmarketable assets (despite the trustee’s having some control here)

• Any specific date

• The marriage, divorce, or death of a non-charitable beneficiary

• A non-charitable beneficiary’s specific birthday (e.g., reaching age 18)

The sale of marketable assets (e.g., publicly-traded stock) is not a triggering event.

Developing a well-functioning flip CRUT takes careful planning and coordination between your accountant, trust attorney, and sometimes valuation experts—ideally all under the leadership of the people who know your complete financial situation best, your financial advisors.