Beware the Tax Traps: Navigating the Murky Waters of CRATs and Monetized Installment Sales

Hey there, just thought I’d share some important tax info with you all! The IRS recently sent out a warning (IR 2023-64) to high-income folks about some sketchy arrangements involving charitable remainder annuity trusts (CRATs) and monetized installment sales. Basically, some promoters are advertising these strategies to lure clients in, but they’re not following the rules. The problem is, taxpayers are the ones responsible for their tax returns, not the promoters who got them into the mess.

So, what’s up with CRATs? These are irrevocable trusts that let you donate assets to a charity and then get an annual income either for life or for a set period of time. In the IRS warning, they mentioned that they’re keeping an eye on these trusts to make sure everything is above board. Some people try to misuse them to avoid paying taxes on ordinary income and capital gains from selling property. They might wrongly claim that transferring property to a CRAT bumps up its value as if it had been sold to the trust. The CRAT then sells the property but doesn’t recognize the gain because of this supposed step-up in value. Finally, the CRAT buys a single premium immediate annuity with the money from the property sale.

The issue here is that taxpayers, or beneficiaries, might misuse some tax code sections to treat the remaining payment as tax-free, which isn’t right.