A Strategy to Sell Highly Appreciated Assets
The potential for lifetime income, and still leave something to your heirs. By Alden B. Tueller, Esq., contributing author of Today’s Retirement
Steve Stewart is 62. His wife, Sandy, is 61. Almost 25 years ago, they bought their home for $350,000. They worked hard, made a decent living, and raised four children. However, now they’d like to sell their home, and downsize into a planned community. Steve and Sandy have their home appraised. They are very excited to find that the property’s current value is over $1,800,000! The Stewarts are ecstatic until they visit with a tax advisor who tells them about capital gains tax.
The advisor explains that if they sell the property they will realize a gain of $1,342,000 ($1,800,000 sales proceeds, less the original price of $350,000 and selling expenses of $108,000.) Under current year 2012 tax law, $500,000 of their gain is excludable from income for tax purposes. The balance of $842,000 is taxable at 23% (combined state and federal tax) in their situation. When they sell the property their tax bill will be $193,660. Please remember this is a hypothetical example and is not representative of any specific investment. Your results may vary.
Before they sink into despair, the tax advisor explains, “There is an alternative route around the problem, one you need to know about. You can place the taxable portion of the property in your own tax-exempt charitable remainder trust, also known as the Capital Gains Bypass Trust (CGBT), thereby avoiding the tax due on that portion. By doing so, you will also get a charitable deduction that will help you keep more of the sale proceeds outside the trust. As named trustees and income beneficiaries of the trust, you will maintain control of the proceeds from the sale of the property both inside and outside the trust, receive the income from the portion inside of the trust for the rest of your lives, and do whatever you want with that income and with the portion of the sale proceeds outside of the trust. Do this and you may be able to still leave your family more money. Let me explain how…”
The Advantage of Using a Tax-Exempt Trust Rather Than Selling Outright
The Stewarts’ tax advisor suggests that, instead of selling all the property outright, they sell outright only that portion that will be free of tax because of (1) the $500,000 exclusion, (2) the fraction of the basis and selling expenses allocated to this portion, and (3) the charitable deduction that they get from creating the tax-exempt Capital Gains Bypass Trust, also commonly known as the charitable remainder trust (CRT) with the balance of the property. Computer software can readily calculate all these amounts. It’s called the “zero-tax” alternative. They will name themselves as the trustees and income beneficiaries of the CRT. The Stewarts will then control the investment of the proceeds inside the CRT as well as the proceeds kept outside the CRT. He lists many of the advantages the Stewarts may benefit from:
- Potentially avoid capital gains tax on the sale. They can have 100% of the sale proceeds of $1,800,000 (minus $108,000 of selling expenses) to invest rather than the $1,498,340 they’d have if they sell the property outright.
- Tax-free cash outside the CRT of $1,020,214.
- Income for life from the $671,786 CRT. (After the death of the first spouse, the survivor will continue to receive the income). They choose a 6% annual payout from the CRT. The Stewarts allocate the assets into investments with which they feel comfortable.
- An immediate charitable deduction. For the Stewarts, assuming a 6% payout rate, the charitable deduction will amount to $165,374 or an actual cash tax savings of $71,111. This amount could also be reinvested to leave to their family, or it could be used to insure the Stewarts’ lives for the benefit of their family, say, to augment any amount of the $1,020,214 that they have not consumed as of their deaths.
- Avoid or reduce estate tax. The property placed in the CRT will be wholly or partly removed from the Stewarts’ estate. The CRT assets will also avoid probate proceedings.
- Satisfaction of knowing they will be making a substantial gift to a charity of their choosing, to be used in accordance with their wishes.
Depending on how they invest and consume the income from the CRT and the cash held outside the CRT, the Stewarts’ children may have the opportunity to receive more than they would have if the CRT had not been used.
The Disadvantages of the CRT
Of course, every strategy has some inherent disadvantages. Some disadvantages of utilizing a CRT versus an outright sale of the property area as follows:
- The CRT will only pay an income stream that can be taken either monthly, quarterly, semi-annually, or annually. Funds held within the trust are not accessible and this is an irrevocable choice.
- Income from the CRT varies per year according to the return of the underlying investments. This means if the return is greater than the payout amount, your income will increase, however, if the return is less than the payout amount, your income will decrease.
- Loss of potential growth on assets gifted to the CRT.
- The gift is irrevocable; you may not retain any interest in gifted properties (that is, you couldn’t continue to live in the home after it is gifted to the trust.)
- Attorney and administration fees are involved with setting up and administrating the CRT.
However, in certain cases, the advantages may outweigh the disadvantages and potential risks.
Who Can Benefit?
Individuals or couples with an appreciated asset(s) that will be subject to capital gains tax if sold. Real estate, a business, stocks – almost any asset of value qualifies. Don’t hesitate to sell because of taxes – harvest your gain using tax advantaged strategies. Please keep in mind, no strategy assures success or protects against loss.
The CRT is one method to sell a capital gains taxable asset for cash with the potential to pay zero taxes. If you would like to learn more about this strategy, please contact Today’s Retirement at 888-446-8275 or go to www.atsfinancial.com.
Tax & Legal Note:
This information is not intended to be a substitute for specific individualized tax or legal advice. We strongly suggest that you discuss your specific situation with a qualified tax or legal advisor.