Updated: Jan 31, 2019
Reprinted by permission of the Los Angeles Business Journal™
There is a way to Sell Appreciated Assets without a Capital Gains Hit
Are you thinking about selling a highly appreciated asset and reinvesting the profits, but you’re worried about how much money you’ll lose to capital gains taxes?
The solution is to take advantage of Section 664 of the Internal Revenue Code and transfer your assets to a Capital Gains Bypass Trust.
Most people feel that the only way to unlock their frozen assets is to sell them, pay the capital gains taxes due then reinvest the balance. However, they don’t know that a CGBT can protect them from taxes.
A CGBT, also known as a Charitable Remainder Trust (CRT), is an irrevocable, qualified trust that pays income for a period of time defined as the lifetime of the owner or the lives of the non-charitable beneficiaries, or as a term of years. After which time, the trust assets are distributed to a tax-exempt, charitable beneficiary.
The best assets to place in a CGBT are ones that are greatly appreciated and ready to be sold by the owner. A CGBT allows for the sale of assets to bypass capital gains taxes; it also creates a current charitable income tax deduction and avoids any future estate tax. And it provides an increased income from the sale of assets, since 100 cents on the dollar can be invested. This increases the yield by as much as 28 to 35 percent.
Example I: Harold Greenfield owns a house, which originally cost him $100,000. Today, 20 years later, the fair market value is $800,000. Harold would like to sell the house and reinvest the proceeds.
Harold sells the property in the traditional manner, paying capital gains taxes at a rate of 28 percent, amounting to $196,000. Harold reinvests the balance of $604,000 with a money manager, who projects a total return of 10 percent per year, or $60,400.
This was a good strategy, but could Harold have done better? The answer is yes. Notice that Harold was taxed nearly $200,000 – twice the amount he originally paid for the house.
Example 2:John Weltman owns a house, which also cost him $100,000 20 years ago. John’s house has also appreciated to $800,000 and he is interested in selling his investment.
However, upon consultation with his financial adviser, John decides to transfer the asset to a Capital Gains Bypass Trust. The trustee, who in this case happens to be John, sells the house and reinvests the proceeds with a professional money manager, who projects a total return of 10 percent per year, or $80,000.
The added income results because John doesn’t have to pay any capital gains taxes – allowing him to reinvest $800,000 – the total market value of the home. In addition, John will receive a charitable income tax deduction, equivalent to about $200,000.
Over his lifetime, John will receive an additional $640,000 total income more than Harold will. And, upon John’s death, $800,000 will go to the charity of John’s choice.
To increase the net assets passing to the grantor’s family at death, the grantor can redirect some of the trust income into an insurance policy. Through the use of an irrevocable trust as owner and beneficiary, the insurance would be structured so that the proceeds would go, free of estate tax, to the grantor’s family or other desired beneficiaries.
If the grantor is at an age where insurance is highly expensive or unobtainable, the CGBT can be extended over multiple lives, with the insurance coverage placed on another non-charitable beneficiary; for example, a spouse or a child.
The CGBT can also be used for future retirement planning, when a qualified plan is undesirable or not an available alternative. During the grantor’s working years, he or she would make periodic contributions to the trust, which would qualify for the charitable income tax deduction. When the grantor retires, the trust might sell some or all of the assets free of capital gains tax and re-deploy the proceeds into high-yielding investments.
Another advantage of a CGBT is that assets can be placed in a trust that has been previously set up, allowing a tax-free shift into a more diversified array of investments.
The non-charitable beneficiaries of a CGBT can be either the grantor or someone whom the grantor chooses, such as his or her children, brother, sister or spouse.
According to the wishes of the grantor, the recipients can receive income for any period of time, such as their lifetime or two lifetimes (including spouse and children). At the end of the term of the trust, the grantor’s chosen qualified charitable organization, or his or her private foundation will become beneficiaries.
The three types of trustees are a qualified corporate trustee, such as a bank or commercial trust company; a qualified charitable organization, with trust powers granted by the state; or anyone else whom the grantor deems competent, including him or herself. It is the trustee’s responsibility to manage the trust assets, including receiving, selling and reinvesting the assets. The trustee is also responsible for distributing income to the non-charitable beneficiaries.
If you decide to sell highly appreciated assets, one of your best options is the use of a Capital Gains Bypass Trust.
Boscoe is a Certified Financial Planner with Brighton Advisory Group in Encino.