Charitable trusts do two things at once: they support causes you care about and they solve a tax problem. In California the tax problem is usually the same one — a highly appreciated asset that cannot be sold without a very large bill. A rental property bought in 1988, a concentrated position in a company that went public, a family parcel that has quadrupled in value. Because California taxes capital gain as ordinary income at rates that top the nation, the combined federal and state cost of a sale is frequently the single largest obstacle to a Californian’s financial plan.
A charitable remainder trust is tax-exempt. It can sell that asset without immediate tax to the trust, reinvest the full proceeds, and pay you an income stream for life or a term of years, with what remains going to charity. That is the core of most California charitable planning. The Holmes Law drafts charitable remainder and charitable lead trusts, coordinates them with the rest of an estate plan, and advises trustees on California’s registration and reporting requirements.
Charitable Remainder Trusts
A charitable remainder trust, governed by Internal Revenue Code section 664, is an irrevocable trust that pays an income stream to one or more noncharitable beneficiaries — usually the donor, or the donor and spouse — for life or for a term of up to 20 years. Whatever remains at the end passes to one or more qualified charities.
The statutory requirements are specific. The annual payout must be at least 5% and no more than 50% of the relevant value, and the actuarial value of the charitable remainder must be at least 10% of the initial fair market value of the property contributed. A trust that fails either test is not a CRT and none of the benefits follow.
Annuity Trust or Unitrust
A charitable remainder annuity trust (CRAT) pays a fixed dollar amount, set as a percentage of the initial value and never changing. It is predictable, it is a hedge against poor investment returns, and it provides no inflation protection. No additional contributions may be made after funding.
A charitable remainder unitrust (CRUT) pays a fixed percentage of the trust’s value as revalued each year, so the payment rises and falls with the portfolio. It offers inflation protection and accepts additional contributions. Most CRTs created today are unitrusts.
Two unitrust variants matter for illiquid California assets. A net income unitrust pays the lesser of the stated percentage or the trust’s actual net income, with a makeup provision in the NIMCRUT version that catches up shortfalls in later years. A flip unitrust begins as a net income trust and converts to a standard unitrust on a triggering event — typically the sale of the contributed property. The flip structure is the standard answer when a CRT is funded with real estate that may take months or years to sell, because it avoids obligating the trust to make payments before it has cash.
Why the Tax Exemption Matters So Much in California
A CRT is generally exempt from income tax under section 664(c). When the trust sells the appreciated asset, no tax is due at the time of sale. The entire sale proceeds — not the after-tax remainder — are available for reinvestment, so the income stream is calculated on a larger base.
Take a California rental property with a very low basis. Sold outright, federal capital gains tax, the net investment income tax, depreciation recapture, and California income tax at ordinary rates together consume a substantial share of the proceeds before anything is reinvested. Contributed to a CRT and sold by the trustee, none of that is paid at the moment of sale, and the full amount works for the income beneficiary.
The gain is not erased — it is deferred and recognized gradually as distributions are made. Under the four-tier system of section 664(b), each payment carries out ordinary income first, then capital gain, then tax-exempt income, then a tax-free return of principal. The beneficiary pays tax over many years instead of all at once, at a much lower present cost.
The Charitable Deduction
The donor receives an immediate income tax charitable deduction for the present value of the charitable remainder, calculated actuarially using the applicable federal rate, the payout percentage, and the term or the beneficiaries’ ages. Deduction limits based on adjusted gross income apply, with a five-year carryforward for the unused portion. Because a higher payout rate leaves a smaller remainder, the income stream and the deduction move in opposite directions, and the right balance depends on whether the donor’s priority is cash flow or current-year tax relief.
When a CRT Fits — and When It Does Not
The strongest California candidates share a profile: a highly appreciated, low-basis asset the owner wants to diversify out of; a desire for lifetime income; genuine charitable intent; and heirs who will be adequately provided for by other assets.
It is a poor fit where the donor may need the principal back — a CRT is irrevocable and the assets are gone. It is a poor fit where the property carries a mortgage, since debt-encumbered property creates serious complications including unrelated business taxable income and potential bargain sale treatment. It is a poor fit where the owner intends to hold the asset until death, because assets in the estate receive a stepped-up basis and the built-in gain disappears without any trust at all. And there is no reason to use one where the charitable intent is absent, because the remainder genuinely goes to charity.
Families who want both the CRT and an inheritance for their children often pair it with an irrevocable life insurance trust — sometimes called wealth replacement — funded from a portion of the increased cash flow the CRT produces, so the death benefit replaces for the heirs what the charity ultimately receives.
Charitable Lead Trusts
A charitable lead trust reverses the order. Charity receives the payment stream for a term, and the remainder passes to family members at the end. It is primarily a wealth transfer tool rather than an income tool.
Like CRTs, CLTs come in annuity (CLAT) and unitrust (CLUT) forms. The gift to the remainder beneficiaries is valued at funding as the contributed amount less the present value of the charitable payments, so if the trust’s assets outperform the IRS assumed rate, the excess passes to family free of additional gift or estate tax. CLATs are therefore most attractive when the applicable federal rate is low relative to expected returns.
A grantor CLT gives the donor an immediate income tax deduction for the present value of the charitable payments, but the donor is then taxed on the trust’s income during the term. A non-grantor CLT gives no upfront deduction; the trust itself claims a deduction for what it pays to charity. Which is right depends on whether the donor has an unusually high income year to offset.
Unlike CRTs, charitable lead trusts are not tax-exempt entities, and there is no minimum remainder requirement.
Alternatives Worth Comparing
A charitable trust is not always the right vehicle, and the alternatives are simpler:
- Donor-advised fund. An account at a sponsoring charity. Immediate deduction, no setup cost, no separate tax return, no trustee, and appreciated securities can be contributed and sold without tax. What it does not do is pay you an income stream, and you give up legal control over the grants. For a donor who simply wants a deduction and a vehicle for future giving, a DAF is usually the better answer than any trust.
- Private foundation. Maximum control over investments and grantmaking, and the ability to involve family across generations. In exchange: excise taxes, an annual distribution requirement, strict self-dealing prohibitions, public reporting, and meaningful administrative cost. It is often organized as a California charitable trust or nonprofit corporation.
- Charitable gift annuity. A contract with a charity rather than a trust — the charity pays a fixed annuity for life in exchange for the gift. Simple, and the payments depend on the charity’s own solvency.
- Qualified charitable distribution. For donors over 70½, a direct transfer from an IRA to charity that satisfies required minimum distributions without adding to adjusted gross income, subject to an annual limit.
- Testamentary charitable gifts. A gift at death produces an estate tax charitable deduction under section 2055, and naming a charity as beneficiary of a traditional IRA is particularly efficient, since the charity pays no income tax on the distribution while individual heirs would.
California Attorney General Oversight
This is the California-specific piece that out-of-state templates miss. Charitable trusts in California are supervised by the Attorney General under the Supervision of Trustees and Fundraisers for Charitable Purposes Act, Government Code section 12580 and following. The Attorney General maintains the Registry of Charities and Fundraisers, and trustees holding assets for charitable purposes are generally required to register and to file annual reports.
Split-interest trusts occupy a narrower position: a charitable remainder trust with a living noncharitable income beneficiary is generally outside the registration requirement while that interest continues, but the analysis depends on the trust’s terms and on when the charitable interest becomes present. A private foundation organized as a California charitable trust is squarely within it. Because the consequences of non-registration include delinquency status and penalties, this should be determined when the trust is created rather than years later.
The Attorney General also has standing to enforce charitable trusts and must be given notice of proceedings affecting them — which means a charitable trust cannot quietly be modified among the interested private parties the way a family trust sometimes can.
Administering a Charitable Trust
A CRT files an annual information return, and the trustee must value the assets each year for a unitrust, calculate and make timely distributions, track the four income tiers for beneficiary reporting, and manage investments under the prudent investor rule while balancing the income beneficiary’s interest in current return against the charitable remainder’s interest in growth.
Self-dealing rules apply. The donor cannot buy assets from the trust, borrow from it, or use trust property, and prearranging a sale of the contributed asset before the transfer can cause the gain to be attributed back to the donor under assignment-of-income principles. A CRT funded with real estate should be transferred before a purchase agreement is signed, not after.
Donors frequently serve as trustee of their own CRT, which is permitted, though a professional or corporate trustee is often worth the fee for the valuation, tiering, and compliance work — particularly for a trust that will run for decades.
Frequently Asked Questions
Can I avoid capital gains tax entirely with a charitable remainder trust?
Not entirely — the gain is deferred, not eliminated. The trust pays no tax on the sale, and the gain is recognized gradually as distributions are made to you under the four-tier rules of section 664(b).
Can I change my mind after funding a CRT?
No. A charitable remainder trust is irrevocable and the assets are no longer yours. You may generally retain the right to change which charities receive the remainder, but not to take the property back.
Can I fund a CRT with mortgaged real estate?
It is problematic. Debt-encumbered property can generate unrelated business taxable income and bargain sale treatment, and may jeopardize the trust’s status. The mortgage should generally be cleared before the transfer.
Would a donor-advised fund be simpler?
Usually yes, if you do not need income back. A DAF gives an immediate deduction and lets you contribute and sell appreciated securities without tax, at no setup cost. Choose a CRT when the lifetime income stream is the point.
Does my charitable trust have to register with the State of California?
It depends on the structure. Trustees holding assets for charitable purposes generally must register with the Attorney General’s Registry and file annually. Split-interest trusts with a living noncharitable beneficiary are treated differently. Confirm the requirement when the trust is created.
Speak With a California Charitable Planning Attorney
The Holmes Law drafts California charitable remainder annuity trusts, unitrusts including net income and flip structures, and charitable lead trusts; compares them against donor-advised funds, private foundations, and testamentary gifts; and advises trustees on administration and California Attorney General registration.
To discuss charitable planning, contact the office. You may also want to review our pages on California trusts, CA irrevocable trusts, and California estate planning.