Recently finalized regulations eliminate a potential tax shelter involving the sale of an interest in a charitable remainder trust (CRT). Here’s an example that illustrates how the tax shelter worked prior to the regulations:

Susan establishes a charitable remainder annuity trust (CRAT), funding it with $150,000 worth of highly appreciated stock and retaining an annuity interest. Susan’s basis in the stock is $50,000, so if she had sold it she would have recognized a $100,000 capital gain, leaving her with $120,000 after taxes (assuming a combined federal and state rate of 30%). For purposes of this example, let’s assume that Susan’s annuity interest in the trust is worth $135,000 and the charitable beneficiary’s remainder interest is worth $15,000.

The trustee immediately sells the stock for $150,000 and reinvests the proceeds in other marketable securities. Because the CRAT is a tax-exempt entity, it’s not subject to tax on the $100,000 capital gain and its basis in the new securities is equal to the $150,000 purchase price. Next, Susan and the charitable beneficiary simultaneously sell their interests to an unrelated third party for $135,000 and $15,000, respectively. The trust terminates and the trust assets are distributed to the third party.

Under the uniform basis rules, Susan receives a proportionate share of the trust’s basis in the securities, which in this case is $135,000. The result: Susan receives the $135,000 purchase price tax-free — $15,000 more than she would have received had she sold the stock outright. Further, she would be eligible for a charitable contribution based on the value ultimately passing to the charity.

Under the new regulations, which generally apply to sales of CRT interests on or after January 16, 2014, Susan is required to reduce her basis by her proportionate share of the CRAT’s undistributed ordinary income and undistributed net capital gain, resulting in a $90,000 gain. After the dust settles, Susan is left with $108,000 after taxes — $12,000 less than she would have received if she hadn’t established the CRAT.