Let's take a look at Michael, a resident living in New York City who got involved with Bitcoin in 2015. He caught the wave of cryptocurrency when it was still early, having bought coins when their prices were in the low four-digit range. Over time, he continued investing at regular intervals, following a systematic and gradual approach called dollar cost averaging. Moreover, his curiosity went beyond just Bitcoin as he also was interested in Ethereum and several other digital asset investments. Today, after investing around $240,000 over the years, his cryptocurrency investment has increased to a staggering $2.20 million dollars. But just like any other smart investor, Michael knows he needs to diversify his portfolio.
Here is where it gets tricky: Without going through the appropriate tax maneuvers, in selling his crypto assets, Michael will owe Uncle Sam approximately $470,000, and then another $265,000 will be added in state and city taxes by New York. All in all, that would be a $745,000 hit.
It is not hard to understand why Michael is leery about giving a large portion of his windfall directly to the government. Within this context, the Charitable Remainder Unitrust, or CRUT, is brought into the equation.
A CRUT is not just a way to provide for charities; it's also a very good tax strategy. In essence, it's a tax-exempt, irrevocable trust. You put assets in the CRUT, and while you continue to enjoy the income from it, the remainder passes to charity upon expiration of the trust. This offers immediate deduction of taxes, along with deferral of taxes on the gains, thereby providing an opportunity to make future gifts to charities.
Let's go through the numbers. Michael's crypto is now valued at $2.20 million, having a cost basis of $240,000. By transferring his crypto into a CRUT, Michael immediately gets a charitable deduction. Using the IRS's calculations, that deduction will be roughly 10% of the current asset value, or $220,000. With New York's high rates, it works out to be about $88,000 in tax savings this year alone. The real magic of a CRUT is that Michael does not have to pay any taxes on the sale of his crypto. Rather than forking over $745,000 in taxes, he gets to keep that money in the trust and reinvest it. For short-term investors who usually have higher capital gains rates, this benefit becomes even more pronounced. In fact, if he had sold assets held for less than a year, his tax bill could have topped $1 million. But with the CRUT, those funds stay at work, growing over time.
Another factor Michael might want to consider is liquidity—how much access will he have to the money in the trust? Here, a CRUT can be surprisingly flexible.
Once his crypto is sold, Michael can start taking out a percentage of the trust's value each year. For a term trust, it could be in the neighborhood of 11%, and for a lifetime trust, closer to 6%. In the case where he goes the lifetime route and his trust grows at an average rate, he could take out approximately $2.19 million over 10 years, coming very close to his starting value in his trust.
Another financial vehicle available to him, to access more funds, is a line of credit. While Michael cannot directly borrow against the CRUT since a portion is held for charitable purposes, he can use the expected income to be derived from the trust as collateral. In this way, he can garner more liquidity when needed without liquidating some of the assets inside the trust. What does this all mean in the long run for Michael? Let's say he held the trust for 40 years. By then, he will have amassed around $20 million in payouts. After taxes, he is left with approximately $12.7 million. On top of that, he gets to give away about $3.8 million to charity. That's the quid pro quo the government will make for allowing his money to grow tax-free. Conversely, if Michael had kept his crypto in a regular taxable account, he'd be looking at about $10.5 million pre-tax or $7 million after taxes. In other words, by using a CRUT, Michael isn't only supporting a good cause; he ends up with an extra $5.5 million in his pocket. That's what I call a win-win.
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