If higher taxes on capital gains are on their way, here are some strategies you need to know to help clients minimize the bite.
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Start Thinking About Capital Gains

The Biden administration’s “American Families Plan” includes several proposals affecting tax on capital gains:

1) It would a proposal eliminate preferential rates on long-term gains for taxpayers making over $1 million/year.

2) It would eliminate Section 1031 tax deferral on real estate gains over $500,000.

3) It would eliminate stepped-up basis for gains over $1 million for individuals and $2.5 million for couples.

4) Finally, it would recognize those excess gains immediately as of the date of death.

While none of those proposals are close to actually passing yet – and, in fact it looks like the top rate on capital gains might float up to a more manageable rate of 25% or so – the discussion in Washington is prompting agita among those with appreciated real estate, businesses, and other assets that would be subject to higher tax under the new rules. So here’s a quick overview of some common strategies you can use to help clients blunt their impact.

Pre-Sale Strategies

These are strategies for clients to implement before actually closing the sale of assets:

Installment sales let taxpayers spread gains over multiple years to defer tax and avoid piling gains into top tax bracket. (Note: this and the following two variations are not available for publicly-traded securities or mutual funds.)

Intermediated installment sales let clients sell to an intermediary buyer (essentially parking the gains into some form of escrow) and defer tax until taking proceeds from that escrow vehicle. These arrangements typically go by names such as “deferred sales trust.”

Monetized installment sales let taxpayers sell an asset to intermediary buyer in exchange for installment note payable in 30 years, then take a nontaxable cash loan equal to nearly 100% of the sale proceeds immediately. This defers tax and creates a time-value-of-money benefit, too.

Charitable remainder trusts (CRTs) let clients transfer appreciated assets to trust and take deduction for net present value (NPV) of remainder interest. The trust then sells asset tax-free and pays income for period certain/life. Assets pass to charity when trust terminates. This is typically not available for pass-through business entities or debt-financed properties.

Pooled income funds (PIFs) let taxpayers transfer appreciated asset to fund and take a current deduction for the NPV of the remainder interest. Fund sells asset tax-free and pays income for life. At death, the assets pass to charity. The PIF is a simplified version of a CRT that doesn’t give the seller flexibility to manage trust portfolio assets; however, a quirk in the rules for valuing the remainder interest may give sellers a bigger up-front deduction. Fund sponsors may or may not accept illiquid assets.

Employee stock ownership programs (ESOPs) let business owners sell part or all of their business interests to a qualified plan. Proceeds will be tax-free if reinvested in “qualified ESOP securities.”

Finally, traditional tax-deferred savings force clients to lock up their money until age 59½ or later. Yes, there may be escape hatches: plan loans, 72(t) withdrawals, or expensive premature distributions with an extra 10% penalty. But the regular restrictions force hard choices on clients who might also eye those savings for college tuition, vacation homes, or similar big-ticket expenses.

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Post-Sale Strategies

Here are some “catch-up” strategies for clients wait until after selling to come to you for help with their tax bills:

Charitable lead trusts (CLTs) let sellers transfer sale proceeds to fund, which pays charity for period of years or lifetime. Trust income is taxable to grantor while trust pays income to charity, making tax-efficient investing crucial. Trust assets revert to grantor/heirs at trust termination. Deduct up to 60% of AGI for NPV of charitable income stream.

Conservation easements let taxpayers transfer part of the sale proceeds to a partnership to offset gains, take charitable deduction for proportionate share of partnership’s contribution (sometimes up to 4-5x investment). The maximum deduction is 60% of the taxpayer’s AGI. Warning: IRS target!

Oil & gas programs let taxpayers use sale proceeds to buy oil & gas interests and deduct 85-95% of their initial investment.

Qualified opportunity zones let taxpayers roll gains from any sale into a qualified opportunity fund to defer tax until 12/31/2026, along with potential savings on gains from the replacement property.

This isn’t a complete list of strategies – for example, we haven’t touched on §1202 stock (which the client either qualifies for or not), or the Malta pension Plan (which may be the ultimate “too good to be true” strategy to frighten clients away). And some large sales might best be broken into chunks to take advantage of different strategies. For example, an entrepreneur selling a tech company might choose to use §1202 for $10 million of gain, the monetized installment sale for another $10 million, a CRT for $20 million, and a straight cash sale for the remaining $10 million to roll the after-tax proceeds into a retirement home in Hawaii.

Still, those of us working with high-net-worth clients and those with high-value businesses and real estate should start learning more about these strategies and more. It might also be a good time to cultivate relationships with business brokers, commercial real estate agents, nonprofit development directors, and even art dealers to generate referrals for tomorrow’s sellers. Opportunity is knocking . . . open the door!

Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.
Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.

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