This blog and the previous one discussed how to manage long-term capital gains taxes. If you did not read the first one, this would be a good time to do that. It covered:
- Calculating capital gains correctly (avoiding the common mortgage mistake)
- Calculating taxes on the gain.
- Five common and popular strategies for managing taxes
This article will cover lesser well-known strategies that should not be overlooked in your tax planning analysis. Again, these explanations are not intended to be comprehensive or exhaustive but a quick taste of what you may want to explore.
7. Charitable Remainder Trust (CRT)
A charitable remainder trust is an irrevocable trust that pays you (and/or your designated beneficiaries) an income stream for life or a term of years, after which the assets are distributed to charity. There are many varieties of charitable remainder trusts.
How it works:
You create the trust and fund it with appreciated assets. You receive an immediate tax deduction for the present value of the charitable gift. The trustee of the trust most often sells the assets without triggering a capital gains tax because it was a charitable gift. The trustee reinvests the proceeds and pays you (and/or your beneficiaries) a fixed annuity or variable payments for life or a period not exceeding 20 years. When the payout period ends, whatever is left in the trust goes to charity.
With a CRT, you get to use the asset during your lifetime and receive payments from it. When you die, the charity receives the remainder of the trust assets free of capital gains taxes.
You give up control of the asset when you create the trust. There are fees associated with setting up and administering a CRT.
Who likes CRTs:
Those who are charitably inclined.
Who tends not to use CRTs:
Those who do not want to give up control of the asset or who do not want to donate to charity.
8. Donor Advised Fund (DAF)
A donor-advised fund is like a personal charitable giving account.
How it works:
You make a donation to a DAF sponsor (a public charity) and receive an immediate tax deduction. The sponsoring organization invests the money and manages all the back-end work (compliance, grants, etc). You then recommend how you would like your charitable dollars to be distributed. The distributions can be made over time.
DAFs are simple to set up, and there is usually no minimum initial contribution required. You get an immediate tax deduction when you make a contribution to your DAF. There is flexibility in how and when you recommend grants from your DAF.
Once you make a contribution to a DAF, you cannot get the money back. You also do not have control over how the sponsoring organization invests your contributions (although most sponsor organizations give donors a choice of investment options).
Who likes DAFs:
Those who want to simplify their charitable giving and/or those who want to make a charitable gift now but are uncertain of where they would like the money to go.
Who does not like DAFs:
Those who want more control over how their charitable dollars are invested or spent.
9. Delaware Statutory Trust (DeST)
A Delaware Statutory Trust (DeST) is an IRS-recognized entity that can be used to hold interests in real estate for investment purposes.
How it works:
You transfer property (real estate, cash, or other assets) to a DeST in exchange for an undivided interest in the trust. The trust then uses the property to produce income and capital gains that flow through to you as a shareholder. Because the DST is a pass-through entity, you will not pay taxes on the sale of your interest in the DST (although you will pay taxes on any distributions you receive from the trust).
The DeST offers tax deferral on appreciation of the underlying assets. It also provides diversification and professional management of your investments. They can provide recurring monthly income, asset appreciation, and 1031 exchange eligibility. DeST’s are great for 1031 exchanges for folks who own real property but want to get out of the management of owning it.
You give up control of the underlying asset(s), the DeST is illiquid, and there are typically few opportunities for an early exit.
Who likes DeSTs:
Those who want to invest in real estate but do not want the hassle of direct ownership. DeSTs are also popular with investors who are looking for tax deferral on appreciation of the underlying assets.
Who does not like DeSTs:
Investors who want more liquidity do not want a longer-term commitment and want more control over the real estate that they own.
10. Opportunity Zones
An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.
How it works:
You can invest in a Qualified Opportunity Fund (QOF) and receive preferential tax treatment on your capital gains. To qualify for the program, you must invest in a QOF within 180 days of realizing capital gains from the sale of another asset. The QOF must then invest in a Qualified Opportunity Zone property. The preferential tax treatment includes deferral of capital gains taxes and, in some cases, a reduction or elimination in the amount of taxes owed.
The Opportunity Zone program provides tax incentives for investment in economically-distressed communities. This can lead to new jobs and economic development in these areas.
Due diligence is critical. Some tax incentives have expired. The 10-year holding rule may be too long or too short, depending on the underlying fund investment. There is a risk that the investments made through QOFs will not have the desired impact on the communities they are supposed to be helping. There is also the potential for abuse of the program by investors who are only interested in the tax benefits.
Who likes Opportunity Zones:
Those who want to invest in economically-distressed communities and receive preferential tax treatment on their capital gains. Those who have a long-term outlook.
Who does not like Opportunity Zones:
Those who are concerned about the potential for abuse of the program or those who do not think the investments will have the desired impact on communities. Those who think a 10-year holding period is too long for their needs.
11. Leave the country
Laugh if you want, but this option has come up in many conversations. Those of you who are not US citizens or green card holders and are only in the US on a visa, you might have options available to you by residing in another part of the globe. If you are intending to move anyway, you might include a capital gains tax management strategy to go with your search.
Any of you regularly following this blog know that I encourage creating a plan first and then choosing your tools (your tax management strategies) to implement the plan. Letting the tax tail wag the dog often produces an outcome you do not intend. Make a plan that fits your life. Make your money work for that plan.
If you would like to explore your capital gains tax strategy, please reach out.
About the Author:
Jessica Lanning JD, CFP® brings focus and perspective to your individual financial needs to identify your opportunities for investment and wealth. Regardless of what you’ve done before or what “mistakes” you think you’ve made, Jessica can help get you back on track quickly and safely. As a former practicing lawyer, she brings a comprehensive approach to legal, tax, and financial challenges so that her clients can enjoy peace of mind. A huge proponent of conscious decision-making, Jessica makes sure her clients are educated and informed so that they make sound decisions with clarity and confidence.
Lanning Financial Inc. is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.