This article provides a detailed comparison of two strategies that are commonly used to tax efficiently diversify appreciated assets: Charitable Remainder Unitrusts (CRUTs) and Opportunity Zones (OZ).

Key Highlights and Takeaways

• Tax-Efficient Diversification: Both CRUTs and Opportunity Zones offer strategies to diversify appreciated assets while deferring capital gains taxes, potentially leading to significantly higher returns compared to outright selling.
• Time Flexibility: Opportunity Zones offer more timing flexibility as you can contribute realized capital gains after a sale while you have to contribute an appreciated asset to a CRUT before the sale to utilize its tax benefits.
• Long-Term Growth: CRUTs provide an income stream and often higher ROI unless you have a top decile OZ Fund

What are CRUTs?

A CRUT is an irrevocable trust that mitigates capital gains tax on the sale of appreciated assets like stock, crypto, real estate, or privately held businesses and then generates income for a beneficiary (or beneficiaries) for a specified period, after which the remaining assets are distributed to a designated charity.

How Do CRUTS Work?

The basic idea is that a person (the “grantor”) transfers appreciated property to a CRUT and, in return, the CRUT pays the grantor (or another beneficiary) a fixed percentage of the assets in the trust each year for either a set number of years or the beneficiary’s lifetime. When the appreciated assets are sold inside the CRUT, there is no immediate federal or state capital gains tax on the sale; the trust can reinvest and grow the assets pre-tax. Instead, the capital gains tax will be paid by the beneficiary (probably the grantor) when the beneficiary receives distributions from the CRUT. While the capital gains tax is eventually paid, in the meantime the grantor is able to reinvest any untaxed amount inside of the CRUT, generating returns on that entire amount. At the end of the term, anything left over in the trust passes to a charity of the grantor’s choice. In addition, the grantor gets a charitable deduction typically equal to ~10% of the assets they contributed to the trust in the first place. The amount that passes to charity is roughly equal to the 10% charitable deduction the grantor receives adjusted for the growth of the assets over time.

Thanks to the combination of this tax deduction and the powerful tax deferral described above, the grantor typically ends up with significantly more post-tax money than he or she would have had without the CRUT — and a charity gets money, too! That’s a win-win. (You can learn more about CRUTs here and you can estimate the potential returns here.)

Benefits of CRUTs

1. Tax Deferral: The primary advantage of a CRUT is its ability to defer capital gains taxes. By selling appreciated assets inside the trust, the donor avoids immediate capital gains taxes when selling the asset and can reinvest and grow the assets on a pre-tax basis. The donor doesn’t pay taxes on the sale (or any income) realized inside the trust; instead, the seller (as beneficiary) pays taxes on distributions from the trust. Over a long period of time, this can more than double the post-tax dollars the seller receives from a sale.
2. Charitable Deduction: In addition, the donor receives a charitable deduction that is typically 10% of the value of assets contributed to the CRUT. That deduction can offset ordinary income or capital gains income.
3. Income Stream: The CRUT provides at least annual distributions for the length of the trust, which can be a set number of years or the lifetime of the beneficiary.
4. Asset Flexibility: CRUTs can be used with almost any asset ranging from public stocks to private stocks, crypto, real estate, and collectibles.

Drawbacks of CRUTs

1. Irrevocability of Charitable Gift: Once assets are transferred into a CRUT, the donor can’t claw back the charitable gift.
2. Illiquidity: During the term of the CRUT, the donor is limited to annual distributions from the CRUT equal to a fixed percentage of the trust’s assets. Short of terminating the CRUT entirely, there’s not much the donor can do to access the bulk of the principal during the CRUT term.
3. Income Variability: The income generated by a CRUT can vary depending on the performance of the trust’s investments. If the trust’s assets underperform, the income stream may be lower than expected. The flip side is that if the investments overperform, the income stream may be higher than expected. (You can use our CRUT calculator here.)

What is an Ideal CRUT Situation?

Imagine that Bob, a 40-year-old California resident, has a $1,000,000 asset with a cost basis of zero. He wants to sell the asset in a tax-efficient way so he can receive some of the sales proceeds every year to support his lifestyle. If he contributes that asset to a standard CRUT that is designed to last for his lifetime, he’ll get annual distributions from the CRUT equal to about 7% of the value of the CRUT’s assets. So, in Year 1, he’ll get a $70,000 distribution (7% of $1,000,000), in Year 2 he’ll get a distribution equal to about 7% of the value of the CRUT’s assets at that time, and so on. In the meantime, Bob, as Trustee of the CRUT, will generate returns investing the ~$350,000 that would have been taxed immediately without the CRUT. Over his life, Bob will be able to receive about $1,400,000 more after taxes (a 124% additional return) by using the CRUT than he would have been able to generate without it.

What are Opportunity Zones?

Opportunity Zones are a popular tax-advantaged investment strategy. Investors who have realized capital gains (from the sale of stocks, real estate, business interests, or other investments) can roll those gains into a special type of real estate investment fund called a Qualified Opportunity Fund (”QOF”). QOFs invest in government-designed geographic areas called “Opportunity Zones” — areas with a lot of poverty and under-investment. An investor who invests in a QOF within 180 days of realizing the gain will receive two valuable tax benefits. First, he or she will be able to defer capital gains on the QOZ investment until it is sold or exchanged, or the end of 2026, whichever comes earlier. Second, the investor will be able to adjust the cost basis of their investment. If the investor holds the investment for at least 10 years, he or she can avoid taxes entirely on the sale of the Opportunity Zone investment. Once the money is in the QOF, the investor’s returns are tied to how well the real estate projects in the QOF perform.

Benefits of Opportunity Zones

1. Tax Deferral: By investing in Opportunity Zones, investors can delay paying capital gains tax on the money they move into the fund until December 31, 2026.
2. Tax Reduction: If the investment is held for at least 10 years, investors can avoid capital gains taxes on the Opportunity Zone investment.

Drawbacks of Opportunity Zones

1. Investment Risk: Returns depend on the success of the QOF’s projects.
2. Limited Liquidity: To get the full tax benefits, investors need to keep their money in the QOF for at least 10 years, which means they won’t have easy access to the capital during that time.
3. Fees: QOFs have high upfront and annual fees.
4. Negative Cash Flow: If you invest now in a fund that closes at the end of 2024, you would likely not have liquid access to your QOF investment funds until at least 2030, but you would owe taxes on your deferred gains at the beginning of 2027. Without proper planning, this could create a cashflow issue for you.
5. Concentrated Real Estate Exposure: Opportunity Zone funds invest in a small number of real estate projects. As a result, investors in these projects wind up with concentrated exposure to two to five real estate projects.

What is an Ideal Opportunity Zone Situation?

Imagine that Kyle, a 45-year-old California resident, has a $1 million property with a cost basis of zero. He wants to diversify the asset because it has appreciated so much, but he doesn’t need the cash proceeds from the sale. He wants to invest in a QOF, in part because he doesn’t have much real estate exposure in his portfolio. If Kyle doesn’t take distributions for 11 years, rolling his gains into a QOF will increase his post-tax returns by 45% (from $2.2 million to $3.2 million).

Choosing Between CRUTs and Opportunity Zones

When Does One Clearly Make More Sense than the Other?

The choice between a CRUT and an Opportunity Zone often depends on an individual’s financial goals, tax considerations, and philanthropic intentions.

1. Individual Wants Income Stream: If an individual’s primary goal is to use the proceeds of the sale to support his or her lifestyle, a CRUT will usually have a higher ROI. The sooner (and the larger share of the proceeds) a person wants cash flow from the sale, the higher the returns from a CRUT will be relative to an Opportunity Zone. The exception to this is if you want all the proceeds from the sale distributed to you between 8-15 year from now.
2. Already Realized Capital Gains: If you have already sold your appreciated asset, you can’t utilize the benefits of a CRUT which leaves an Opportunity Zone as your only choice as long as you’ve sold your asset within 180 days. That being said it really only makes sense to use an Opportunity Zone is you believe its a top decile OZ fund and you want concentrated real estate exposure.
3. Don’t Want Concentrated Real Estate Exposure: Deferring your capital gains with an Opportunity Zone forces you to reinvest your assets in concentrated real estate while a CRUT gives you the flexibility to invest in real estate, public/private stock, crypto, collectibles or a combinations of them.

Close Calls and Secondary Considerations

Sometimes, the choice is less clear cut. What if an individual is looking to sell an appreciated asset, but isn’t sure if they’ll need the income stream or to what extend they’ll need it? Here are two other factors to consider:

1. You Want Real Estate Exposure: If an individual doesn’t need the capital to support his or her lifestyle and plans to pass on the assets to future generations, it’s a close call whether to choose between a CRUT and Opportunity Zone (if those are the only option). In reality, that’s because there are better trust options to use in this situation like GRATs, IDGTs or NGTs.
2. Solving for Returns and Believe You Have a Top Quartile OZ Fund: Due to fees, you probably need an OZ Fund to have a 15-30% higher return than the stock market to achieve comparable returns, plus you should account for the higher risk because it is a concentrated and undiversified investment. Which is why it typically only makes sense to use an OZ for a portion of your portfolio and you have high conviction in the OZ fund.

CRUT and Opportunity Zone Case Study

Consider Jane, a tech entrepreneur with a $5 million concentrated public stock position in a successful company she co-founded. Jane is 55 years old and has plans for retirement, with a strong desire to contribute to environmental causes. Her stock has appreciated significantly, and she wants to sell it to support her lifestyle but is concerned about the tax implications of selling her shares.

Assumptions:

• Annual distributions starting at $190k/year (after taxes) that increase by 5% per year.
• Public Market and Opportunity Zone Investments grow 10% per year.

Results:

• Both structures are significantly better than doing nothing.
• A CRUT distributes ~80% more after taxes to Jane than an opportunity zone.

Conclusion

Choosing between a CRUT and an Opportunity Zone requires careful consideration of various factors, including tax efficiency, income needs, philanthropic goals, and control over assets. Both strategies offer unique advantages and potential drawbacks, making it essential to align the chosen approach with the individual’s broader financial objectives. You can use our Comparison Calculator here to understand the financial trade-offs.

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