Crypto Tax Trap: Are the Tax Advantages of a Charitable Remainder Trust Worth It for Canadian Cryptocurrency Investors?

Introduction: Charitable Remainder Trusts & Cryptocurrency Tax Planning

Many Canadian cryptocurrency investors and cryptocurrency traders seek tax planning options, allowing them to legally reduce their Canadian income tax burden of their cryptocurrency-based income. One option that seems to have gained popularity among Canadian cryptocurrency investors and traders is the use of a charitable remainder trust.

The idea is that a charitable remainder trust provides Canadian cryptocurrency investors and cryptocurrency traders with a means of leveraging their cryptocurrency holdings for the purposes of generating donation tax credits, which they can then use to offset the tax relating to their cryptocurrency profits.

But do the tax benefits of a charitable remainder trust make sense for most cryptocurrency investors and traders?

After providing an overview of charitable remainder trusts and their Canadian tax benefits, this article explains why a charitable remainder trust doesn't make sense for most Canadian cryptocurrency investors and traders. It concludes by offering pro tax tips from our expert Canadian crypto tax lawyers.

What is a Charitable Remainder Trust?

Before describing a charitable remainder trust, we should first explain the notion of a trust.

The legal concept of a trust came from equity, a body of law developed in the English Court of Chancery and adopted by Canadian courts. The trust concept depends on equity's recognition that legal ownership could be separated from beneficial ownership. A person legally owns a property if his or her name is on title, yet the beneficial owner is the real owner of the property even though it might be in someone else's name.

A trust is a relationship between a trustee, a beneficiary, and a property. And that trust relationship depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property. The trust's creator (also known as the settlor)will often burden the trustee with duties to maintain or manage the trust property in the beneficiary's favour. For instance, the settlor might require that the trustee manage a large sum of money, cryptocurrency, or investments for a child or disabled beneficiary.  

While a trust divides property interests between the legal titleholder and the beneficial owner, property interests can also be divided in another way: life tenancy and remainder interest. A life tenancy is a legal arrangement that allows one person, called the life tenant, to use and benefit from a property during the life tenant's lifetime.

When the life tenant dies, the property goes unencumbered to another person, known as the remainder person. While the life tenant remains alive, the remainder person holds a remainder interest in the property; when the life tenant dies, the remainder person acquires full ownership of the property.

During the life tenant's life—that is, while the life tenancy remains intact—the life tenant yields the right to possess the property and earn income from the property in which the tenant holds the life interest, and the remainder person cannot interfere with the life tenant's right to possess and earn income from the property.

Yet the life tenant must preserve the property burdened with life tenancy; the life tenant cannot take any action that might damage the capital value of the property saddled with the life interest. Nor can the life tenant sell or transfer the property if doing so would affect the rights of the remainder person. 

A charitable remainder trust is therefore a type of trust that depends on both distinctions—i.e., the distinction between legal and beneficial ownership and the distinction between a life tenant and the remainder person. With a charitable remainder trust, you transfer property to a trust whereby you retain a life interest in that property and make an irrevocable gift of the residual interest to a registered charity. 

In more technical terms: a charitable remainder trust is one where a donor settles property into a trust in which the trustee is charged with administering the property for the benefit of the settlor during the settlor's lifetime and with transferring full ownership of the property to the registered charity after the settlor's death.

Here's generally how it works:

1. Donor Contributions. The donor transfers assets (such as cash, stocks, cryptocurrency, or real estate) into the trust.
2. Income Payments to Life Tenant. The trust pays a specified percentage of the trust's value or a fixed amount to the donor for the donor's lifetime.
3. Charitable Beneficiary. When the donor dies, the life tenancy comes to an end, and the trustee must distribute the remaining assets in the trust to one or more designated charitable organizations (which are identified in the trust deed).

This trust structure basically allows a donor to make a charitable contribution while also retaining an income stream from the donated assets for the donor's lifetime. It can be an effective estate-planning tool, offering both charitable and financial benefits.

What Are the Canadian Tax Implications and Tax Benefits of Employing a Charitable Remainder Trust? 

Creating a trust triggers several Canadian income tax implications.

First, unless a tax-deferred rollover applies (e.g., the spousal rollover), settling the property into the trust results in a deemed disposition for the settlor. This means that, upon creating the trust, the settlor must, for income-tax purposes, report and pay tax on any capital gain that had accrued on the property. 

The same thing applies to Canadian cryptocurrency investors who settle cryptocurrency into a charitable remainder trust. To settle the trust, the cryptocurrency investor must transfer to the trust the beneficial interest in the remainder interest in the cryptocurrency. This transfer constitutes a "disposition" for Canadian income tax purposes, and the settlor will therefore trigger capital gains tax based on the value of the remainder interest in the transferred cryptocurrency. (For the reasons that we discuss in the following section, the value of the remainder interest in cryptocurrency will typically equal the value of an outright interest in that cryptocurrency.)  

But the charitable remainder trust gives rise to an offsetting donation tax credit if the remainder interest goes to a charity registered with the Canada Revenue Agency. In other words, the donor may receive an immediate charitable income tax deduction based on the present value of the donated property that will eventually go to charity. So, if the trust beneficiary is a CRA-registered charity, the charity can issue a donation tax receipt, thereby allowing the donor to claim a tax credit, which will typically offset the capital gain that the donor realized upon settling the charitable remainder trust.

As a result, when properly structured, the charitable remainder trust allows the donor to gain an immediate donation tax credit for the remainder-interest donation while still retaining an income stream from the life tenancy in the donated assets.

Does a Charitable Remainder Trust Make Sense for Canadian Cryptocurrency Investors and Traders?

Typically, when people gift a remainder interest in property, they do so with real property. This is because a life tenancy in real property still gives the life tenant a number of options. For example, a donor who retains a life tenancy in real property is still allowed to continue living in the real property for the remainder of the donor's life (if the real property is a personal-use property) or continue receiving rental income from the property for the remainder of the donor's life (if the property is a rental property).

Although it's possible to gift a remainder interest in personal property, such as cryptocurrency, people rarely do it because doing so severely restricts the benefits available to the life tenant. This is because the life tenant must preserve the corpus of the property for the benefit of the remainder person.

The obligation to preserve the property's corpus severely restricts what a life tenant can do with personal property. For example, with stocks, the life tenant can continue to receive dividends (if the stocks do indeed pay dividends), but the life tenant generally cannot sell the stocks. And the life tenant probably cannot lend out the stocks because doing so may impose too great a risk for the remainder person's interest in the stocks. 

With cryptocurrency, it's even worse: Cryptocurrency's principal use is to be traded. It doesn't do much other than that. It has no personal-use aspect. Moreover, cryptocurrency in and of itself doesn't generate passive income. To generate passive income by virtue of owning cryptocurrency, you need to either stake the cryptocurrency (if the platform relies on the proof-of-stake validation) or lend out the cryptocurrency.

But just as lending stocks might impose too great a risk for the remainder person's interest in the stocks, lending cryptocurrency might impose too great a risk for a remainder person's interest in cryptocurrency. So, a person who holds a life tenant in cryptocurrency probably won't be permitted to lend it. The same might be true for staking cryptocurrency, but this is a very novel legal question that calls for a thorough tax-law analysis by a knowledgeable Canadian crypto-tax lawyer.

In any event, with cryptocurrency, the life tenant's obligation to preserve the property's corpus means that, after donating the remainder interest in the cryptocurrency, the life tenant can't benefit from the cryptocurrency in any meaningful way.

A further complication with cryptocurrency donations is this: What registered charity would even be interested in accepting a donation in the form of a remainder interest in cryptocurrency? Probably none. As a result, in most cases, it makes no sense for a cryptocurrency donor to donate the cryptocurrency's remainder interest while retaining a life tenancy; the cryptocurrency donor who wants to attain a donation tax credit may as well donate the cryptocurrency outright—assuming, of course, that the registered charity even accepts cryptocurrency donations. 

Pro Tax Tips & Expert Canadian Crypto-Tax Lawyer Tax Guidance

This article demonstrates one of the many potential tax traps for Canadian cryptocurrency traders and investors. Canadian cryptocurrency-related tax planning demands expert legal advice from a Certified Specialist in Taxation Canadian crypto-tax lawyer.

Our elite Canadian crypto-tax lawyers can devise tax-planning solutions that are tailored to your specific circumstances and goals. For example, a Canadian cryptocurrency trader may derive greater tax benefits from incorporating a cryptocurrency-trading business. If the corporation qualifies as a Canadian-controlled private corporation (CCPC), its first $500,000 in cryptocurrency-trading profits will qualify for the reduced small-business-deduction (SBD) tax rate. Read our article for more details on the Canadian tax benefits of incorporating a cryptocurrency-trading business.

A CCPC allows the Canadian cryptocurrency trader to enjoy favourable income-tax treatment through a legal entity that facilitates—rather than undermines—the cryptocurrency trader's objectives. To compare: If the same cryptocurrency trader had employed a charitable remainder trust, the resulting legal obligations would have deprived the trader of the very thing that the trader required: the ability to trade cryptocurrency.

For tax-planning solutions that account for your specific circumstances and facilitate your goals, consult one of our knowledgeable Canadian crypto-tax lawyers today.

Frequently Asked Questions

What is a trust?

A trust is a relationship between a trustee, a beneficiary, and a property. And that trust relationship depends on the distinction between beneficial and legal ownership: the trustee legally owns the property; the beneficiary (unsurprisingly) beneficially owns the property. The trust's creator (also known as the settlor)will often burden the trustee with duties to maintain or manage the trust property in the beneficiary's favour. For instance, the settlor might require that the trustee manage a large sum of money, cryptocurrency, or investments for a child or disabled beneficiary.  

What is a life tenancy?

A life tenancy is a legal arrangement that allows one person, called the life tenant, to use and benefit from a property during the life tenant's lifetime. When the life tenant dies, the property goes unencumbered to another person, known as the remainder person. While the life tenant remains alive, the remainder person holds a remainder interest in the property; when the life tenant dies, the remainder person acquires full ownership of the property.

During the life tenant's life—that is, while the life tenancy remains intact—the life tenant yields the right to possess the property and earn income from the property in which the tenant holds the life interest, and the remainder person cannot interfere with the life tenant's right to possess and earn income from the property. Yet the life tenant must preserve the property burdened with life tenancy; the life tenant cannot take any action that might damage the capital value of the property saddled with the life interest. Nor can the life tenant sell or transfer the property if doing so would affect the rights of the remainder person. 

What is a charitable remainder trust?

A charitable remainder trust is a type of trust that depends on the distinction between legal and beneficial ownership and the distinction between a life tenant and the remainder person. With a charitable remainder trust, you transfer property to a trust whereby you retain a life interest in that property and make an irrevocable gift of the residual interest to a registered charity. In more technical terms, a charitable remainder trust is one where a donor settles property into a trust in which the trustee is charged with administering the property for the benefit of the settlor during the settlor's lifetime and with transferring full ownership of the property to the registered charity after the settlor's death.

What are the Canadian tax implications and benefits of creating a charitable remainder?

Creating a trust triggers several Canadian income tax implications. First, unless a tax-deferred rollover applies (e.g., the spousal rollover), settling the property into the trust results in a deemed disposition for the settlor. This means that, upon creating the trust, the settlor must, for income-tax purposes, report and pay tax on any capital gain that had accrued on the property. The same thing applies to a Canadian who settles property into a charitable remainder trust. To create the trust, the settlor must transfer to the trust the beneficial interest in the remainder interest in the property. This transfer constitutes a "disposition" for Canadian income tax purposes, and the settlor will, therefore, trigger capital-gains tax based on the value of the remainder interest in the settled property. 

But if the remainder interest goes to a charity registered with the Canada Revenue Agency, the charitable remainder trust gives rise to an offsetting donation tax credit. In other words, the donor may receive an immediate charitable income tax deduction based on the present value of the donated property that will ultimately go to charity when the life tenant dies.

So, if the trust beneficiary is a CRA-registered charity, the charity can issue a donation tax receipt, thereby allowing the donor to claim a tax credit, which will typically offset the capital gain that the donor realized upon settling the charitable remainder trust. As a result, when properly structured, the charitable remainder trust allows the donor to gain an immediate donation tax credit for the remainder-interest donation while still retaining an income stream from the life tenancy in the donated assets.

I'm an active Canadian cryptocurrency trader. I'm considering whether I should put my cryptocurrency inventory into a charitable remainder trust. Does this make sense for my situation?

Probably not.When you create the charitable remainder trust, you effectively transfer a beneficial interest in the remainder of the cryptocurrency to the charity, and you'll retain a beneficial interest in a life tenancy in the cryptocurrency. As the life tenant, you have an obligation to preserve the corpus of the property for the benefit of the remainder person—i.e., the charity.

With cryptocurrency, the life tenant's obligation to preserve the property's corpus means that, after donating the remainder interest in the cryptocurrency, the life tenant can't benefit from the cryptocurrency in any meaningful way—especially by selling it. In other words, by employing a charitable remainder trust, the resulting legal obligations will deprive you of the very thing that you require for your cryptocurrency-trading business: the ability to trade the cryptocurrency.

You'll likely derive greater tax benefits from incorporating a cryptocurrency-trading business. If the corporation qualifies as a Canadian-controlled private corporation (CCPC), its first $500,000 in cryptocurrency-trading profits will qualify for the reduced small-business-deduction (SBD) tax rate. A CCPC allows you to enjoy favourable income-tax treatment through a legal entity that facilitates—rather than undermines—your objectives as a cryptocurrency trader.

Cryptocurrency-related tax planning demands legal advice from a Canadian tax lawyer specializing in crypto-tax issues. For tax-planning solutions that account for your specific circumstances and facilitate your goals, consult one of our knowledgeable Canadian crypto-tax lawyers today.

DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.