Are taxes really inevitable? Maybe, but with proper planning they can be minimized!
When selling a highly appreciated asset, capital gains tax is always an issue. If it is property that has been depreciated over time, recaptured depreciation is also a concern. Triggering the AMT is a good bet as well. Most investors have no true concept of the amount of their gain that will go to taxes when they sell outright.
Most actually think 15% is all they will owe, but in reality it is usually closer to 25-45%.
Selling businesses or closing down corporations also trigger more tax than is thought. It matters whether you sell an asset within a business and then have to get the money out of the business and into your personal account (often meaning additional income tax) or if you sell the business as a whole as shares or percentage ownership.
No one disagrees there is a tax problem, but finding out what options are available and best suit your needs is the greatest challenge.
Here are the choices under current tax law. Not all are available to every type of asset sale. There are many rules to follow for each, but below the concepts are explained briefly for the sake of this article.
1. A 1031 exchange. If you have real estate held for investment, this is a good continuation strategy, because you can exchange your property for another of equal or greater value and defer all of your tax consequences. You can also do a 1031 exchange into a tenant in common property if you no longer wish to deal with the headaches of being a landlord and property manager
2. A Charitable Bargain/Installment Sale. Used in combination, this is the most recent offering and perhaps the most beneficial of all of the exit strategy choices. You are basically exchanging your asset (business, real estate, stock portfolio, collection, cash, annuity, etc.) for a series of guaranteed payments over a fixed number of years. You are able to spread out your taxable obligation (capital gains tax) over these years and pay it in small chunks versus one huge lump sum at time of sale. Although recaptured depreciation is paid at time of sale, the amount due is greatly reduced by a large charitable deduction and the amount forever forgiven. There are also additional benefits, as a public charity makes the sale for you. Among them are:
a. A large charitable deduction up front that can be used to reduce your taxable income from all sources by 30-50%, depending on the type of asset sold. This can be carried forward for up to 6 years total if not fully used in the first year.
b. A partial forgiveness of both capital gain and recaptured depreciation (if applicable) forever.
c. Return of the asset less bargain component over the stated contracted period with 5.5% interest as a series of guaranteed payments.
d. Less and less taxable income each year from the amortization schedule of the payments.
e. A contribution to charity for a good cause as in the other charitable sales.
f. The time/value of compounding money, since the bulk of your tax burden remains working for you over time.
g. The asset is partially removed from your estate.
h. The asset passes to your heirs per your instructions should you pass away before receiving all of your guaranteed payments. They can receive it in trust to minimize their tax burden, or as a lump sum with remaining taxes due at receipt.
3. A Charitable Remainder Trust (CRT, CRUT, CRAT, etc) or Charitable Gift Annuity.
a. These methods are well documented and do have their place. Basically, the asset (or major portion of it) is earmarked for a charity at your death and you, the seller, receive an up front tax deduction and the interest the asset is able to generate during the course of your lifetime. Your tax burden is relieved since a charity doesn’t pay taxes, but you may have to pay recaptured depreciation and other taxes from a mortgage payoff at time of sale. This option is usually best suited for those with large estates and charitable intentions. It also can be used in combination with the charitable bargain/installment sale if the intent is to get the biggest up front charitable tax deduction, and with a Dynasty Trust if you need to remove the entire amount from your estate.
4. A Structured Sale. This strategy is offered by a couple of large insurance companies to spread out the capital gains tax obligation over time. Your buyer assigns the obligation to make installment payments back to you over a fixed number of years at a fixed interest rate to an Assignment company owned in part by the associated insurance carrier. The proceeds are invested in a Single Premium Immediate Fixed annuity which will make the payments back to you over the designated number of years. All recaptured depreciation must be paid up front and no additional tax deductions are offered except the ability to spread out your capital gains tax obligation over time. You are locked in at a fairly low interest rate for the length of the contract. One should always compare the benefits side by side, but this option does impose several major limitations.
5. A combination of two or more of the above options. It doesn’t have to be all or nothing, and you may choose to keep a portion out and pay taxes at time of sale.
The worst injustice you can do is not educate yourself on the options available to you. You always have the right to pay your tax bill, but doing it from a position of knowledge assures you that you have all the facts and choose what is in your best interest.
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