How Does a Charitable Remainder Trust Avoid Capital Gains? (w/Examples) + FAQs

Quick Answer: A charitable remainder trust (CRT) is tax-exempt, so when it sells your appreciated asset it pays $0 capital gains tax up front, for tax year 2025 and 2026. You don’t avoid the tax forever, though. You defer and spread it over years of payments under the four-tier rule of IRC Section 664.

This article reflects federal rules and general state rules as of June 2026 and covers tax years 2025–2026. Tax law changes — confirm current figures before you file. This is educational, not legal or tax advice for your specific situation; a complex CRT warrants a CPA, tax attorney, or estate attorney.

You hold stock or land that has grown for decades. If you sell it outright today, the IRS takes a slice of every dollar of growth as capital gains tax. A charitable remainder trust lets you move that asset into a tax-exempt trust first, so the trust sells it with no immediate tax, and you keep an income stream from the full, undiminished sale proceeds.

The stakes are real and the timing matters. The federal long-term capital gains rate reaches 20%, plus a 3.8% net investment income tax, so a large sale can lose nearly a quarter of its gain to tax in a single year. According to the IRS Statistics of Income, tens of thousands of CRTs file returns each year, holding tens of billions in assets — a sign that this is a mainstream, IRS-sanctioned tool, not a loophole.

Here is what you will learn:

• 💸 How a CRT legally sells your appreciated asset with zero immediate capital gains tax.
• 🔄 Why “avoid” really means “defer and spread” — and the four-tier rule that decides your tax.
• 🧮 Worked dollar examples for low-basis stock, real estate, and a business sale.
• ⚖️ The difference between a CRAT and a CRUT, plus Flip and NIMCRUT variations.
• 🚩 The abusive CRAT-annuity scheme the IRS now treats as a listed transaction.

What a Charitable Remainder Trust Actually Is

A charitable remainder trust is an irrevocable trust you create and fund with an asset, defined under IRC Section 664. The word “irrevocable” means you give up control — once the asset goes in, you cannot take it back. In return, the trust pays income to you (or another person you name) for a set period, and whatever remains at the end goes to a charity you choose.

The “remainder” is the part the charity keeps at the end, which is why the trust carries that name. You are called the donor or grantor. The person who receives the payments is the income beneficiary, often you and your spouse. The charity is the charitable remainderman.

The key fact that drives everything in this article: a properly drafted CRT is exempt from income tax under Section 664(c). That single feature is the engine behind the capital gains benefit. Because the trust itself owes no tax when it sells, your full appreciated asset can be converted to cash and reinvested without a tax bite first.

The consequence of getting the structure wrong is severe. If the trust fails to meet the strict Section 664 rules, it can lose its tax-exempt status, and the sale becomes fully taxable. That is why a CRT is drafted by an estate attorney, not from a template.

A common misconception is that the donor “still owns” the asset. You do not. You hold a right to payments and a charitable deduction, but the trust owns the asset. What you should do next: confirm with an estate attorney that your trust document tracks the sample CRT forms the IRS publishes, because using the IRS-approved language is the safest path to qualification.

How the Capital Gains “Avoidance” Actually Works

The mechanism is simpler than it sounds, and it rests on one rule: the trust is tax-exempt, so it sells your asset, not you. When you transfer a highly appreciated asset to the CRT and the trustee sells it, no capital gains tax is due at the moment of sale.

Compare two paths. If you sell a $1 million stock with a $100,000 basis, you owe tax on $900,000 of gain right now. If the CRT sells that same stock, the trust pays nothing, and the entire $1 million is reinvested to generate your income payments. You earn returns on money that would otherwise have gone to the IRS.

This is where the word “avoid” needs an honest correction. You do not erase the capital gains tax. You defer it, and you pay it slowly, only as gains are carried out to you through your payments under the four-tier ordering rule below. In many cases you spread a one-time tax hit across 10, 20, or more years, often into lower-rate years.

The Four-Tier Income Rule (Section 664(b))

Every dollar the CRT pays you carries a tax character set by the ordering rule in Section 664(b), explained in IRS Notice 98-20. The trust must pay out its most heavily taxed income first and its least taxed income last. This is sometimes called “worst-in, first-out.”

The four tiers, in order, are: first, ordinary income (including current and prior undistributed amounts); second, capital gains; third, other income such as tax-exempt income; and fourth, return of principal, which is tax-free. So the big capital gain from your asset sale sits in tier two and is doled out to you over time as you receive payments.

The consequence is that your “tax-free” sale is really a deferred, metered tax. A real example: if your CRT holds $900,000 of stored-up capital gain and pays you $60,000 a year, a large share of each payment is taxed as capital gain until that $900,000 is used up. What you should do next: ask your CPA to project the tier breakdown of your payments for the first five years, so you are not surprised at tax time.

The Upfront Charitable Deduction

Funding a CRT also gives you an immediate income tax deduction in the year you fund it. The deduction equals the present value of the charity’s future remainder interest, calculated using the IRS Section 7520 rate, which is 5.0% for June 2026 per Rev. Rul. 2026-11.

The deduction is limited by your adjusted gross income (AGI). Per DAFgiving360, gifts of appreciated assets are generally deductible up to 30% of AGI, with a five-year carryforward for any excess. A higher 60%-of-AGI limit applies to cash gifts, but CRTs are usually funded with appreciated property.

The consequence of ignoring the AGI cap is a wasted deduction in year one. What you should do next: have your advisor run the Section 7520 calculation before funding, because a higher 7520 rate produces a larger charitable deduction for the same trust.

CRAT vs. CRUT: Which Type Fits You

There are two core types, and the difference is how your payment is calculated. A CRAT (charitable remainder annuity trust) pays a fixed dollar amount set at the start. A CRUT (charitable remainder unitrust) pays a fixed percentage of the trust’s value, recalculated every year, so payments rise and fall with the trust.

Both must pay out between 5% and 50% of the trust value each year, and both must leave a projected remainder to charity of at least 10% of the funding value — the “10% remainder test.” A CRAT must also pass a “5% probability test” that it won’t exhaust before the charity is paid.

Trust Feature	What It Means for You
CRAT — fixed payment	Same dollar amount every year, predictable, but no inflation protection; cannot add assets later
CRUT — percentage payment	Payment grows if the trust grows, good inflation hedge; you can add assets over time
10% remainder test (both)	Charity’s projected share must be ≥ 10% of funding value or the trust fails to qualify
5%–50% payout range (both)	Annual payout rate must fall in this band under Section 664(d)

A misconception is that more payout is always better. A higher payout shrinks your charitable deduction and can fail the 10% test. What you should do next: if you want flexibility and inflation protection, lean CRUT; if you want certainty and are older, a CRAT can make sense.

NIMCRUT and Flip-CRUT Variations

A NIMCRUT (net income with makeup CRUT) pays the lesser of the unitrust percentage or the trust’s actual net income, and tracks any shortfall in a “makeup account” to pay later. This is useful when an asset produces little income at first, such as raw land. The trust pays less early, then “makes up” the deficit once income flows.

A Flip-CRUT starts as a NIMCRUT and “flips” to a standard CRUT after a triggering event, often the sale of the funding asset. This is the go-to structure for illiquid assets like real estate or a closely held business. The consequence of choosing the wrong variation is mismatched cash flow — payments you can’t fund. What you should do next: match the trust type to your asset’s liquidity, and let your attorney draft the flip trigger to a permitted event under the Section 664 regulations.

Which Situation Applies to You?

The right move depends on your asset and your goals. Use this to find your path:

• You hold low-basis publicly traded stock and want lifetime income: a standard CRUT or CRAT works cleanly because the asset is liquid and easy to value.
• You hold appreciated real estate that produces little cash: a Flip-CRUT avoids forcing payments before the property sells.
• You own a closely held business heading toward a sale: a CRT can hold the interest, but you must fund it before a binding sale agreement, or the IRS applies the “assignment of income” doctrine and taxes you anyway.
• You are charitably inclined and over age 65 with a large one-time gain: the deduction plus deferral can be powerful, especially paired with lower retirement-year income.
• You are not charitable at all: a CRT is likely the wrong tool, because at least 10% must go to charity and the asset is gone for good.

Worked Example 1: Low-Basis Stock

Meet Dana, age 65, who owns $1,000,000 of tech stock with a $100,000 cost basis, so she has $900,000 of long-term gain. If she sells outright in 2025, she faces roughly 23.8% federal tax (20% capital gains plus 3.8% net investment income tax) on the gain — about $214,200 gone immediately.

Instead, Dana funds a 5% CRUT. The trust sells the stock and pays $0 capital gains tax, so the full $1,000,000 is reinvested. In year one she receives 5% of $1,000,000, or $50,000.

She also gets an upfront charitable deduction. Using a 5.0% Section 7520 rate and a single life at 65, the remainder value to charity is roughly $400,000–$450,000, deductible up to 30% of her AGI with a five-year carryforward. Each $50,000 payment is then taxed mostly as capital gain under tier two until the stored $900,000 of gain is exhausted — deferred, not erased, and spread across many lower-income years.

Worked Example 2: Appreciated Real Estate

Meet Marcus, who owns a rental building worth $2,000,000 with a $400,000 basis, so $1,600,000 of gain. The building barely cash-flows, so a standard CRUT could force payments he can’t fund. He uses a Flip-CRUT.

While the NIMCRUT phase runs, the trust pays Marcus only its net income, which is small. Then the trustee sells the building tax-free at the trust level, the trust “flips” to a standard 6% CRUT on January 1 of the next year, and Marcus begins receiving $120,000 a year (6% of $2,000,000).

Had Marcus sold the building himself, he would have owed roughly $380,800 in federal tax (23.8% of $1,600,000) up front, plus any depreciation recapture taxed at 25%. By using the Flip-CRUT, the trust deferred that tax, reinvested the full $2,000,000, and Marcus pays gains tax only as the tier-two amounts flow out in his annual payments.

Worked Example 3: Business Sale Timing

Meet Priya, who is selling her company. A buyer has made an offer but no contract is signed. She funds a CRT with part of her stock first, then the sale closes.

Because she transferred the shares before any binding sale agreement, the CRT — not Priya — sells those shares, with no immediate capital gains tax at the trust level. If she had waited until the deal was signed, the IRS assignment of income doctrine would have taxed the gain to her personally, even though the trust technically did the selling.

The consequence of bad timing here is total: you lose the entire benefit and still give the asset away. What Priya should do: fund the CRT well before negotiations harden into a binding deal, and document that no sale was “prearranged.”

Forms, Filing, and Deadlines

A CRT files its own annual return, Form 5227, the split-interest trust information return, due April 15 (with extensions available). This is where the trust reports income, the four-tier accounting, and distributions. The trust generally pays no income tax, but the return is mandatory.

When you fund the CRT with non-cash property, you claim the charitable deduction on your Schedule A and file Form 8283 for noncash gifts; assets over $5,000 in value need a qualified appraisal. The trust then sends each income beneficiary a Schedule K-1 that breaks each payment into its four tiers, which you carry to your Form 1040. See our internal guides on how to fill out Form 8283 and how to report a Schedule K-1 for line-by-line help, and our Schedule D and Form 8949 guide for the capital gains side.

The consequence of a missed or botched return is steep: a late or incomplete Form 5227 carries penalties, and a missing appraisal can void your entire deduction. As to cost and timing, expect a CRT to take several weeks to draft, with attorney fees commonly in the $3,000–$10,000+ range plus annual trustee and tax-prep costs — so a CRT rarely makes sense below roughly $250,000–$500,000 of assets.

Mistakes to Avoid

• Selling the asset yourself first. If you sell before funding, you owe the full capital gains tax and the CRT benefit is lost entirely.
• Prearranging the sale. A binding contract before funding triggers the assignment-of-income doctrine, taxing the gain to you anyway.
• Setting the payout too high. A payout above the level that passes the 10% remainder test disqualifies the trust.
• Funding with mortgaged real estate. Debt-encumbered property can create unrelated business taxable income and self-dealing problems, costing the exemption.
• Skipping the qualified appraisal. Without it, the IRS can deny your full charitable deduction on noncash gifts over $5,000.
• Filing Form 5227 late or wrong. Per KDA, most CRT returns are prepared incorrectly, inviting penalties and IRS scrutiny.
• Falling for the CRAT-annuity scheme. The IRS proposed listing certain CRAT-plus-single-premium-annuity deals as abusive listed transactions in 2024.
• Assuming you can undo it. A CRT is irrevocable; you cannot reclaim the asset if your plans change.

The Abusive CRAT-Annuity Listed Transaction

In March 2024 the Treasury and IRS issued proposed regulations (REG-108761-22) targeting a specific scheme. In it, a CRAT sells appreciated property, buys a single-premium immediate annuity with the proceeds, and the beneficiary wrongly treats the payout as a low-tax annuity under Section 72 instead of carrying out the capital gain under Section 664(b).

The IRS rejects that treatment. Promoters of the scheme have been barred by the Department of Justice. If a transaction is listed, participants must disclose it on Form 8886, and penalties for non-disclosure are severe. The lesson: a legitimate CRT defers tax through the four tiers — any pitch claiming the payout escapes the capital gain tier is a red flag.

Does My State Follow the Federal CRT Rules?

Start with the federal baseline: the CRT is income-tax exempt federally, and your payments are taxed to you under the four tiers. Most states with an income tax conform to this general framework, so your state will generally tax your payments much as the federal rules do, tier by tier.

The big variation is at the beneficiary level. If you live in a no-income-tax state — such as Florida, Texas, Nevada, Washington, South Dakota, Wyoming, Tennessee, and Alaska — you owe no state tax on the payments at all, which sweetens the deal. By contrast, high-tax states like California tax CRT distributions as ordinary state income, and California in particular taxes the income to a resident beneficiary.

The consequence of ignoring state law is a surprise state tax bill on payments you thought were lightly taxed. A misconception is that the trust’s situs (where it’s administered) always controls; in practice your state of residence usually taxes you on the payments you receive. What you should do next: confirm your state’s treatment with a local CPA, especially if you may move to a no-tax state during the payout years.

Pros and Cons

• Pro — No immediate capital gains tax: the trust sells tax-free, so your full asset is reinvested, because the CRT is exempt under Section 664(c).
• Pro — Upfront income tax deduction: you deduct the present value of the charity’s remainder in the funding year, lowering current taxes.
• Pro — Lifetime or term income: you convert an idle, low-yield asset into a reliable payment stream.
• Pro — Estate tax reduction: the asset leaves your taxable estate, which can cut federal estate tax.
• Pro — Supports a cause: the remainder funds a charity you care about, a real legacy benefit.
• Con — Irrevocable: you cannot get the asset back if circumstances change.
• Con — Tax is deferred, not erased: capital gains still flow out and get taxed under tier two over time.
• Con — Setup and ongoing cost: legal, trustee, and tax-prep fees make small trusts uneconomical.
• Con — At least 10% goes to charity: heirs receive less than with a straight inheritance.
• Con — Complexity and audit risk: Form 5227 errors and abusive-scheme scrutiny raise the compliance bar.

Do’s and Don’ts

• Do fund the CRT before any binding sale agreement, because timing protects you from the assignment-of-income tax.
• Do get a qualified appraisal for noncash assets, because it preserves your charitable deduction.
• Do match the trust type to your asset, using a Flip-CRUT for illiquid property to avoid forced payments.
• Do run the Section 7520 deduction math first, because the rate directly sizes your write-off.
• Do confirm your state’s treatment, because no-tax states meaningfully boost your after-tax income.
• Don’t sell the asset yourself first, because that triggers the full capital gains tax you were trying to defer.
• Don’t set the payout above the 10% test limit, because the trust will fail to qualify.
• Don’t fund with mortgaged real estate, because debt can create taxable income and self-dealing issues.
• Don’t buy into a CRAT-annuity “tax-free payout” pitch, because the IRS treats it as a listed transaction.
• Don’t skip Form 5227, because late or wrong filing draws penalties and scrutiny.

What to Do Next

1. Confirm you are charitable. At least 10% of the asset goes to charity for good — if that’s a dealbreaker, stop here.
2. Hire an estate attorney to draft the trust using IRS sample CRT language, and choose CRAT, CRUT, or Flip-CRUT based on your asset.
3. Fund the trust before any binding sale so the trust, not you, sells the asset.
4. Get a qualified appraisal for any noncash asset over $5,000 and file Form 8283 with your return.
5. Calendar the Form 5227 deadline of April 15 each year, and have a CPA handle the four-tier accounting and your K-1.
6. Call a professional if your asset is a business interest, mortgaged real estate, or worth over a few hundred thousand dollars — the stakes justify the fee.

Frequently Asked Questions

Does a charitable remainder trust eliminate capital gains tax completely? No. It defers and spreads the tax. The trust sells tax-free, but you pay capital gains as it flows out to you under the four-tier rule of Section 664(b), often over many years and sometimes in lower-rate years.

How much can I deduct when I fund a CRT in 2025? Generally up to 30% of AGI for appreciated property (60% for cash), with a five-year carryforward. The deduction equals the present value of the charity’s remainder, sized by the Section 7520 rate.

What is the Section 7520 rate right now? 5.0% for June 2026, per IRS Rev. Rul. 2026-11. A higher rate produces a larger charitable deduction for the same CRT, so the funding month can matter.

What is the minimum payout for a CRT? 5% of the trust value each year, with a maximum of 50%. Both CRATs and CRUTs must stay inside this band under Section 664(d).

What is the 10% remainder rule? The charity’s projected share must be at least 10% of the asset’s value at funding. If the trust fails this test, it does not qualify as a CRT and the sale becomes taxable.

Is a CRT revocable? No. A CRT is irrevocable. Once you fund it, you cannot take the asset back, so it suits assets you are ready to part with.

CRAT or CRUT — which is better? It depends on your goals. A CRAT pays a fixed dollar amount for predictability; a CRUT pays a percentage that grows with the trust and allows added contributions and inflation protection.

Do I pay state tax on CRT payments? Usually yes, in states with an income tax, tier by tier. In no-income-tax states like Florida or Texas, your payments escape state tax entirely.

Which IRS form does a CRT file? Form 5227, the split-interest trust information return, due April 15 with extensions. The trust usually owes no income tax but must file every year.

What is the abusive CRAT-annuity scheme? A listed transaction the IRS proposed targeting in 2024. It uses a CRAT to buy an annuity and wrongly treats the payout as a low-tax annuity instead of carrying out the capital gain.

Can I be my own trustee? Sometimes, but it’s risky. Self-trusteeship raises self-dealing and valuation concerns. Many donors use an independent trustee, especially with hard-to-value assets.

How long can a CRT last? Up to 20 years, or for one or more lives. You choose a fixed term of no more than 20 years or payments for the lifetime of the named beneficiaries.

This article reflects federal rules and general state rules as of June 2026 and covers tax years 2025–2026. Confirm current figures and your state’s treatment with a licensed professional before you act.