Tactics to Reduce Your Capital Gains Tax and Inheritance Tax

Biden’s administration and Congress have proposed sweeping changes in the way long-term capital gains are taxed both during your lifetime and after your death. While none of these proposals are final, and perhaps never will, they raise the question of what tactics are available to reduce or defer taxes on valued assets. A likely strategy that has been suggested to mitigate the cumulative effect of the capital gains tax and inheritance tax changes, which will consume over 75% of any estate over $ 3.5 million. dollars and consists mainly of highly valued goods, is to reap the capital gains every year. In other words, perform a transaction that realizes capital gains each year, in an amount that keeps the taxpayer’s income below the $ 1 million level where the highest tax is triggered. When the gains are realized, the assets processed receive a new cost base. The challenge then is how to reduce or defer the tax due on these transactions. Fortunately, there are proven tactics for doing this.

Here is an overview of the tactics that are now available; and, unlike 1,031 exchanges of the same nature, donor-advised funds, income mutual funds and the like, are not on the table as requiring changes in proposed tax laws.

Charitable residual trusts are the best way to defer payment of capital gains tax on appreciated assets, if you can transfer those assets into the trust before they are sold, to generate income over time.

When a Charitable Residual Annuity Trust (CRAT) is established, your donation of cash or property is made to an irrevocable trust. The donor (or other non-charitable beneficiary) retains an annuity (fixed payments of principal and interest) from the trust for a specified number of years (up to twenty years) or for the life (s) of the non-charitable beneficiary . At the end of the term, an eligible charity that you specify receives the balance of the trust property.

Donations made to a CRAT qualify for charitable tax deductions on income and donations; and, in some cases, a charitable deduction of inheritance tax for the balance of interest, only whether the trust meets the legislative criteria. The annuity paid must be either a specified amount expressed in dollars (e.g., Each non-charitable beneficiary receives $ 500 per month) a fraction or a percentage of the initial fair

the market value of the property contributed to the trust (eg the beneficiary receives 5% each year for the rest of their life).

You will receive a tax deduction for the present value of the remaining interest which will ultimately be transferred to the qualifying charity. Government regulations determine this amount, which is essentially calculated by subtracting the present value of the annuity from the fair market value of the property and / or cash placed in the trust. The balance is the amount the grantor can deduct when the grantor donates the property to the trust.

A Charitable Fund Trust (CRUT) is identical to a Charitable Annuity Trust. except that instead of a fixed amount or a percentage of the original donation amount, the annuity is a specific percentage of the balance of the assets of the trust at the beginning of the year in which payments are due.

Primary Charitable Trusts

A charitable master trust is the best way to speed up charitable deductions to both reduce the negative effects of the new limits on itemized deductions and to offset up to 50% of your adjusted gross income in any year of income. taxation. It can also be used to eliminate gift or inheritance taxes on transfers to children or other beneficiaries.

A CLAT is created by transferring money or other assets to an irrevocable trust. A charity receives fixed annuity payments (principal and interest) from the trust for the number of years you specify. At the end of this period, the assets of the trust are transferred to the remaining non-charitable person (or persons) that you specified when setting up the trust, this person can be any person, yourself, a spouse. , a child or grandchild, even someone unrelated to you.

You can set up a CLAT while you are alive or upon your death. Corporations and individuals can create master trusts, which is useful when you need to withdraw valued assets from a business tax-free.

If you are the beneficiary, you will benefit from an immediate and significant tax deduction. In the second and subsequent years, you have to report the income earned by the trust, less the amounts actually paid to the charity in the form of an annuity.

One benefit of the CLAT is the acceleration of the charitable deduction in the year you make the donation, even if the payment is spread over the life of the CLAT. For example, if you have sold a highly valued asset this year, but you can reasonably expect that in the years to come your income will drop significantly, you may have a very high deduction in a high tranche year, even if you have to report that income in the lower bracket years. In effect, you are spreading income (and tax) over many years.

Another advantage of CLAT is that it allows a “low cost” gift to family members. Under current law, the value of a donation is determined at the time the donation is made. The remaining male family member must wait until the charity’s tenure expires; therefore, the value of this remainder of human interest is discounted for the “time cost” of the wait. In other words, the cost of donating is reduced because the value of the donation is decreased by the value of the annuity interest given to a charity.

When the trust assets are transferred to the remaining man, any appreciation in the value of the assets is free from gift or inheritance tax in your estate.

A Unitrust Master Charitable Trust is the same as a Charitable Master Annuity Trust except that the payment to a charity is a percentage of the assets of the trust at the beginning of the year in which the annuity payments are due.

Qualified Opportunity Zone Funds

The Qualified Opportunity Zone fund is new, but it has the potential to be a powerful tool for both deferring capital gains and achieving a tax-free return on investment.

A new provision in the Tax Cuts and Jobs Act 2017 creates the Zone of Opportunity program, a program intended to stimulate long-term capital investment in struggling communities by providing tax benefits on investments in FOQs. Originally introduced in the Investment in Opportunity Act (IIOA) – this is the first new community development tax incentive program introduced since the Clinton administration.

A QOF is a passive investment fund that invests 90% of its capital in new opportunities in opportunities areas. QOFs certified by the Treasury can pool and deploy investment capital in areas of opportunity by investing in stocks, partnership interests and commercial properties. US investors in the QOF benefit from a tax deferral for a minimum of five years and a maximum of seven years, as well as other tax advantages on unrealized capital gains invested in the Fund. In addition, any appreciation of the investment that remains in the fund for more than ten years can be cashed tax free. The benefits of investing realized capital gains in a QOF include:

● Tax on realized capital gains reinvested in an opportunity fund is deferred until the investment is sold or before December 31, 2026, whichever occurs first.

● The basis of capital gains reinvested in an opportunity fund. The base is increased by 10%, if the investment in the Opportunity Fund is held by the taxpayer for at least 5 years, and by an additional 5% if it is held for at least 7 years, thus excluding up to 15 % of the initial tax gain, and

● A permanent exclusion from taxable income of capital gains from the sale or exchange of an investment in an opportunity fund, if the investment is held for at least 10 years. This exclusion only applies to earnings accrued after investing in an opportunity fund.

A few funds exist but invest in specific projects (eg a hotel) or location (eg Detroit or Seattle) and have only started to attract investors. Among these, the funds use the structure of Private Equity, “Hedge” Funds which is: 1) limited partnerships, 2) reserved for “qualified investors”, 3) investors have no control over the decisions of investment, 4) the funds are locked in for five to ten years, and 5) an annual fee of 2% or more. That said, there are very few restrictions on who and how a person can create a fund on their own.

Deferred sale trust

A deferred sale trust is where you sell a highly valued asset to an irrevocable trust in exchange for a remittance note. The trust then sells the asset to a third party. Under IRC Section 453, you only pay tax on earnings and interest as it is paid to you. The trust does not pay any tax on the sale of the assets to a third party because the trust was given a new cost base on the installment sale. The trust can then reinvest the proceeds in other assets or a replacement estate vehicle (such as life insurance), with the death benefit triggered at the same time as the term of the note ends, such as your death.


My recommendation to those with highly valued assets who expect their estates to exceed $ 3.5 million is to learn more about these tactics and their pros and cons. Also consider implementing a ‘Plan B’, such as an alternative gift in an estate to a primary charity, to reduce or eliminate inheritance tax owed, if there are any highly valued assets in the estate, or select and search for a QOZ Fund as a way to defer earnings. Either way, these cannot be put in place in a hurry and require planning of alternatives. whether the actual changes in tax laws are different from the proposals.

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