tax benefits

The Power of Giving the “Right” Assets to Charity, Part 2

Don’t overlook real estate and privately owned business interests              

Key Takeaways:

  • Cash is always appreciated, but there are better assets to give charitably.

  • Charitable gifts of appreciated marketable securities can provide dramatically enhanced tax benefits.

  • Real estate and privately owned businesses may offer the greatest overall charitable tax benefits.

In Part 1 of this article, we explored how gifts of assets other than cash—primarily appreciated marketable securities--can provide a tax advantaged way to support the causes and organizations you believe in.

While many of you are aware that you can gift appreciated marketable securities in lieu of cash, the opportunities to secure these enhanced tax benefits are too often missed. Even more frequently missed are opportunities to give real estate and privately owned business interests prior to a sale. These assets often provide even greater tax-leveraged opportunities because the income tax basis for these assets is often lower than the basis of your marketable securities. Thus, there’s a greater built-in gain that is subject to tax upon sale.

For example, real estate that has appreciated in value and that has been depreciated over time will often have a very low income tax basis. A successful business that was started from the ground up may have little to no basis. So, while publicly traded stock worth $500,000 with a basis of $250,000 would generally be considered a good asset to give to charity, a gift of real estate worth the same amount ($500,000) but with a basis of $100,000 would provide even greater tax savings and leverage.

Of course, gifts of marketable securities are significantly easier to facilitate than gifts of real estate and privately owned businesses. And the timing of a sale of marketable securities is generally much easier to control and dictate than a sale of real estate or an interest in a business. However, in the right situations, the additional tax savings and leverage are well worth the extra effort and complexity. For many families, the bulk of their wealth may be tied up in their businesses or real estate investments, and they may not have a significant marketable securities portfolio from which to gift appreciated assets. In those situations, a gift of real estate or an interest in a privately owned business may be your only leveraged opportunity for giving from non-cash assets.

Conclusion 

Charitable giving in general--and giving non-cash assets in particular--can help you mitigate your tax burden significantly while doing more to support the causes you believe in. as always, check with your advisors and the intended recipients of your philanthropy before making your generous gifts.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

The Power of Giving the “Right” Assets to Charity, Part 1

You can donate appreciated marketable securities to your favorite causes in lieu of cash —don’t miss out on the tax benefits you deserve.

Key Takeaways:

  • Cash may be the worst asset you can give charitably.

  • Charitable gifts of appreciated marketable securities can provide dramatically enhanced tax benefits.

  • Real estate and privately owned businesses may offer the greatest overall charitable tax benefits.

 

Charitable gifting of non-cash assets can be especially advantageous in high-income-tax states such as New York, Vermont, New Jersey, Oregon and California.

What is the single biggest mistake that generous and affluent people make when it comes to planning their charitable giving? Giving exclusively in the form of cash.

When it comes to charitable giving, most people think about writing a check or dropping some cash in the Salvation Army’s red kettle at Christmas. This mindset can be unfortunate—and costly. Non-cash assets can be a much better way to give.

First, there are generally enhanced tax benefits to giving certain non-cash assets such as marketable securities, real estate and privately owned business interests, thus enabling you to pay less in taxes and/or give more to your favorite charities and causes.

Second, non-cash assets are where the majority of your wealth probably resides. According to IRS statistics, of all the giving that is done in the United States each year—about $380 billion—80 percent of all giving in the U.S. is simply made in the form of cash. That means only 20 percent of gifts are made in the form of non-cash assets, much of which include tangible personal property such as clothing, appliances, books, etc. that are gifted to organizations such as the local Goodwill.

That’s a huge lost opportunity.

However, if we look at the cumulative composition of wealth owned by families, cash represents less than 10 percent. Therefore, much of the wealth comprising the other 90 percent provides excellent opportunities for charitable giving, but too often is never considered.

Why cash is not king

As mentioned earlier, cash is often the least advantageous asset to give charitably. True, you generally receive a charitable income tax deduction, which may significantly reduce your tax liability. But, certain types of appreciated non-cash assets—such as marketable securities, real estate and privately owned business interests—may provide double tax benefits by securing the same or similar charitable income tax deductions, and helping you avoid capital gains tax that would otherwise be triggered upon the sale of such assets.

A charitable gift of cash is eligible for a charitable income tax deduction against ordinary income tax rates up to 60 percent of your adjusted gross income (AGI). This can be a very significant benefit and incentive for you to give charitably. For example, you can save up to 37 percent on cash contributions to charities for federal tax purposes and may save additional taxes at the state level. In high-income-tax states, with rates as high as 13.3 percent (California), the highest-income taxpayers may be paying almost 50 percent of their income in combined federal and state taxes. In such situations, you may essentially be receiving a matching dollar-for-dollar contribution from the federal and state governments for your charitable contributions. For every dollar you give, you save as much as 50 cents in taxes.

Clearly, our federal and many state tax codes provide generous incentives and benefits to taxpayers who are generous.

However, even greater tax benefits can be secured by giving certain appreciated assets instead of cash. Consider a taxpayer in the highest federal income tax bracket (37 percent) in a state with a 5 percent income tax rate—a 42 percent total tax rate. He’s considering making a $250,000 charitable gift in support of a charity that is building a hospital in Africa. If he simply writes a check for $250,000, he’ll save $105,000 in taxes.

The power of giving marketable securities to charity

Now, instead of writing a check, suppose he selected some of his most highly appreciated stocks from a marketable securities portfolio, gave the stock to charity, and then took the cash he otherwise would have given to charity and repurchased the same stocks (or different investments if desired). If the stocks selected were originally purchased for $100,000, upon sale he would recognize $150,000 in capital gains. Taxes owed upon sale would include a federal capital gains tax of 20 percent, a state income tax of 5 percent and the Obamacare tax on net investment income of 3.8 percent for a total tax rate of 28.8 percent. On $150,000 of gain, this amounts to a tax liability of $43,200.

However, by giving the stock to charity and allowing the charity to sell the stock, the $43,200 of taxes otherwise due upon the sale would be completely avoided. He would receive the same charitable income tax deduction of $105,000 as he would have by giving cash.

So, a $250,000 cash gift would have cost him $145,000 due to the tax savings from the charitable income tax deduction, while a $250,000 gift of appreciated marketable securities would cost him only $101,800. He would save $43,200 more in taxes by simply giving stock instead of cash. The charity ends up with the exact same amount of funding, though some of you may decide to give some (or all) of this additional tax savings to charity as well—for which you will receive an additional charitable deduction. It’s important to keep in mind that gifts of non-cash assets to public charities are deductible up to 30 percent of the giver’s AGI, compared to cash, which is deductible up to 60 percent of AGI (50 percent if a giver makes a combination of both cash and non-cash assets). Of course, gifts exceeding these thresholds may be carried forward to future tax years for up to five additional years.


Conclusion

Charitable giving in general, and gifts of non-cash assets in particular, can help you mitigate your tax burden significantly while doing more to support the causes you believe in. In Part 2, we’ll explore the value of giving real estate and privately owned businesses.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

This Powerful New Tax Strategy Is a TRIP

Key Takeaways

  • Total Return Pooled Income Funds (TRPIFs) can be powerful tools for gifting, estate planning and minimizing taxes.

  • TRPIFs allow you to make gifts of cash, publicly traded stock, closely held C Corps, unleveraged real estate, tangible personal property like art, cars, antiques and even LLC interests.

  • TRPIFs have many similarities to charitable remainder trusts, but it’s important to understand the differences. Always consult with your financial advisors before signing on the dotted line.

Now that your tax returns are hopefully completed I thought I’d share with you one of the best kept secrets in estate planning and tax mitigation. It’s been around since 1969, but most successful taxpayers and their advisors still don’t know about it.

How about a strategy that completely eliminates capital gains tax, provides a gigantic income tax deduction, distributes all its income (maybe for three generations) and is completely legal? Sounds too good to be true. Well it’s not. Here’s why:

The Pooled Income Fund (PIF), created in code section §642(c)(5) in 1969, and long the red headed step child of planned giving tools, has gone “beast mode.” Thanks to a perfect storm of low interest rates, technology and charities now understanding the need to be responsive to CPAs and other professional advisors (and donors) has ushered in a new type of PIF called the Total Return Pooled Income Fund (TRPIF). This vehicle is one of the most flexible, powerful and thought-provoking planning tools you can deploy.

Yet not many advisors and philanthropically-minded individuals know about them.

With a TRPIF, you may make gifts of cash, publicly traded stock, closely held C Corps, unleveraged real estate, tangible personal property like art, cars, antiques and even LLC interests. Income can be paid for one, two or three generations of income beneficiaries if they’re alive at the time of the gift. Competitive TRPIFs pay out all rents, royalties, dividends and interest as well as all short-term gains and up to 50 percent of post-gift realized long term gains.

Charitable beneficiaries are decided on by the donor, not by the TRPIF trustee. That means the donation goes to any charities the family feels are worthy.

If you know a little bit about CRTs you’ll find that TRPIFs are similar. However, you and your advisor should be aware of some important differences. For instance, a donor can’t be the trustee of his or TRPIF as they can with their CRT. That may be a drawback. However, young donors (couples in their 40s), for instance, can’t even qualify for a CRT as they won’t meet the 10 percent remainder test. With a TRPIF, there is no such test. That means an income beneficiary can be any age. The charitable income tax deductions of a TRPIF can be greater than a CRT’s by a magnitude of four or five times. The methodology by which a new TRPIF (less than three years old) calculates its income tax deduction is governed by a complicated formula based on the ages of the beneficiaries and the assigned discount rate (1.4% for 2018). This is what produces the large deductions.

Conclusion

From a planning standpoint, TRPIFs can allow you much more planning flexibility than many other trusts. When selling a low basis security, for instance, it may be possible to leave more shares in the seller’s hands and still pay no tax because of the larger income tax deduction. And, low-basis assets are only one of the many opportunities that you may applicable to the TRPIF strategy. There are only a small handful of charities offering this new, competitive, Pooled Income Fund. Therefore, it’s important that you ask a lot of pointed questions to the charity.

 

DISCLAIMER: The views expressed in this article do not necessarily express the views of our firm and should not be construed as professional tax advice.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

 

 

Future of Charitable Planning

Key Takeaways

  • Studies show that one in four affluent people (23%) consulted with at least one advisor about charitable donations last year.

  • A confused donor is an unhappy donor.

  • Always review your goals and check with your advisors before whipping out your checkbook

 

Generally planned giving CRTs (charitable remainder trusts) and CLTs (charitable lead trusts) immediately come to mind. We seldom think about charitable giving in the context of non-charitable trusts, but according to Al W. King III, co-founder and co-CEO of South Dakota Trust Company, the amount of wealth that high-net-worth individuals own in trusts is surprising.

  • “The top 1 percent currently have 38 percent of their assets in trusts, and

  • The next 9 percent have 43 percent of their assets in trust,” observed King.

Some families intentionally incorporate charitable planning and provisions into trusts they create. You can too by:

  • Setting a target value for the trust that will be available for family members with any growth and appreciation above that amount being directed to charity

  • Supplementing distributions to family members who work for a charitable organization

  • Matching beneficiaries’ personal charitable contributions

Families are also discovering strategies to incorporate charitable goals and objectives into trusts that were initially created with no charitable intentions. This is often achieved by changing the trust’s situs (legal jurisdiction), reforming or modifying the trust, or “decanting” in states with flexible decanting statutes that allow trustees to change the terms of an otherwise irrevocable trust, which may include adding discretionary charitable beneficiaries.

Common trusts and trust strategies that are increasingly incorporating charitable goals, objectives and planning include:

  • Dynasty trusts—Because of the long-term nature of these trusts, families often desire to make provisions and provide flexibility for both family and charitable goals and objectives.

  • Existing non-charitable trusts—Irrevocable trusts can sometimes be reformed or modified to allow for distributions to charitable organizations. Depending on the applicable state law governing the trusts, it may be necessary or helpful to change the situs of a trust to a state that has more flexible trust decanting laws.

  • Purpose trusts—Some trusts are created for a specific purpose, often to care for “something” rather than for “someone.” For example, a trust may be created to care for a pet; to maintain family property such as antiques, cars, jewelry or memorabilia; or to maintain a family residence or vacation home. Once the pet dies or the property is sold or otherwise disposed of, the remaining assets might pass to charity.

  • Health and education exclusion trusts—These trusts provide support to beneficiaries over multiple generations for certain education and health-related costs. As long as distributions to cover such costs are made directly to an educational or health care institution, then gift taxes and generation-skipping transfer taxes can be avoided indefinitely. However, in order for the vehicle to qualify as a health and education exclusion trust, one or more charitable beneficiaries must have a substantial present economic interest.

Laura Peebles, former tax director of the national office of Deloitte and a consultant to Charitable Solutions, shared these nuggets of wisdom gained from nearly four decades in the charitable planning arena:

  • The donor’s charitable intent determines whether a gift is made. However, the tax benefits can influence the fulfillment of the giver’s charitable intent in terms of the asset that is ultimately given, when the asset is given, and the manner and structure through which the asset is given.

  • A confused donor is not a happy donor.

  • Some tax aspects of charitable giving don’t have good answers, some don’t have inexpensive answers and some don’t have any answers at all.

Charitable giving with retirement benefits

According to author and attorney Natalie Choate, an estate planning and retirement benefits consultant, advisors and many charitably inclined people are well-aware of the substantial tax advantages of giving retirement benefits to charity, particularly in a testamentary capacity. In addition to avoiding any estate tax liability that might otherwise apply, the charity also avoids tax on “income in respect of a decedent” that would otherwise result in the imposition of income tax on retirement benefits received by the owner’s children or other heirs.

In some cases planning charitably with retirement benefits can be quite simple; for example, if a charity is named as the sole retirement plan beneficiary. However, other planning scenarios can involve complex issues and obstacles that must be carefully navigated. For instance:

  • When there are charitable and non-charitable beneficiaries of the same plan

  • When using formula bequests in beneficiary designations

  • When leaving retirement benefits to charity through a trust or estate

  • When using disclaimer-activated gifts to charity.

 

Conclusion


A recent study by U.S. Trust and the Philanthropic Initiative found that one in four wealthy individuals (23%) consulted with at least one advisor about charitable donations in the past year. In addition, nearly 70 percent of charitable remainder trust donors reported learning about the planning vehicle from their advisors.

These trends indicate a growing opportunity for investors and their advisors to have a regular dialogue about charitable methods that meet personal planning goals. Call us at 303-440-2906 if you or someone close to you would like to incorporate a strategic and regular giving strategy into your overall financial plan.



Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Start Your Own Charity

Don’t let a lack of available charities stymie your charitable passions (and tax savings opportunities)


Key Takeaways:

  • If you are passionate about a particular cause and there is no charity that supports it, you can start your own charity.

  • Charities can be set up to support overseas causes as well.

  • Self-started charities can be especially beneficial for those planning to donate over $10,000.

 

Let’s say you are at the stage in life when you want to start giving back in a more consistent and meaningful way. The only hurdle: There is no existing charity that supports the exact causes or initiatives you feel most strongly about. In the past, you’d have to take your checkbook elsewhere.

The good news: With the right planning, you can start a charity to support exactly the causes you care most about--anywhere in the world. There are many charities that are registered in the U.S. that support overseas causes. For instance, Help for Animals India, a charity based in Seattle, was started to help the animals of India. Many alumni groups also set up nonprofit organizations to support the educational institutes at which they studied.

Having said that, while such nonprofit organizations can be formed, the ultimate use of funds is determined by the board of trustees. Under U.S. rules, a domestic charity can’t be committed to give to a particular foreign organization. It can be formed with the intention of supporting a specific organization, but the U.S. board of trustees must make an independent determination that the overseas organization in question qualifies under U.S. rules.

So what does it take for you to set up your own U.S.-based charity, and what should you look out for?


Types of organizations that qualify

According to IRS regs, an organization may qualify for exemption from U.S. federal income tax if it is organized and operated exclusively for one or more of these purposes:

  • Religious.

  • Charitable.

  • Scientific.

  • Testing for public safety.

  • Literary.

  • Educational.

  • Fostering national or international amateur sports competition.

  • The prevention of cruelty to children or animals.

Examples include:

  • Nonprofit old-age homes.

  • Parent-teacher associations.

  • Charitable hospitals or other charitable organizations.

  • Alumni associations.

  • Schools.

  • Red Cross chapters.

  • Boys’ or girls’ clubs.

  • Churches.

To qualify, the organization must be a corporation, community chest, fund, foundation or other entity with articles of association. A trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify.

Set-up process

Step 1: The basics
The basics include:

  • Identifying a cause.

  • Selecting a name and checking with the state corporation office to see whether the name is available.

  • Formulating the mission statement.

Step 2: Incorporation
You and your advisor(s) will need to draw up articles of association and bylaws. The organization must be set up under a state not-for-profit statute. Experts strongly recommend using an attorney experienced in the formation of nonprofit organizations to do this. File the articles of association with the state corporation office.

Step 3: Tax formalities
First the charity will need to get an employer identification number (EIN). This ID is similar to an individual’s Social Security number.

Then you must apply for federal and state/local tax-exempt status as a private foundation. You will also need to fill out Form 1023 or 1024, depending on the type of organization you wish to form. This is by far the toughest and most expensive part of the process. The form runs up to 26 pages with questions that require detailed answers. All the correct documents must be attached to the application to make sure the process runs smoothly.

The user fee per application is $400 for organizations with gross receipts that do not exceed $10,000 annually over a four-year period and $850 for organizations with gross receipts that exceed $10,000 annually over a four-year period.

Further, it takes about a year to be approved. The organization must figure out how to operate while waiting for approval from the IRS. Most organizations say, “IRS tax-exempt status is pending.” The donor shouldn’t claim a tax deduction until IRS status is approved. Also, the organization needs to understand the documentation rules it must follow when other people give contributions.

Conclusion

Again, the upfront time and effort might be best for those considering donating amounts upward of $10,000. There is also an ongoing commitment of time and expense to comply with annual filing requirements at both the federal and state levels. Make sure you and your advisors have all your paperwork in place before getting started. But, most who’ve gone through the process will tell you it’s worth the effort to get it right from Day One. Once you do, you can focus your energies on what you do best—funding causes you believe in, not wrestling with tax rules and regulations.

Contact us any time if you or someone close to you is thinking about taking their philanthropic game to the next level.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Am I eligible for a Qualified Business Income (QBI) Deduction?

Due to recent tax law changes effective 2018, many are left in a state of confusion about what tax credits or deductions their business may qualify for.  For business owners, the Qualified Business Income deduction is one of the most advantageous new deductions available to them.  It allows for qualified businesses to deduct up to 20% of their income, reducing their tax bill by a considerable margin.  What makes a business a “Qualified Business?”

There are a several requirements to qualify for the QBI deduction.  Could your business be qualified for these tax deductions?  Read on to find out:

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

1031 and Done: The Collector’s Curse

Key Takeaways

  • Changes in the rules for personal property under §1031 will limit many collectors, but those changes don’t mean all sellers now have to realize tax on their sales.

  • The Federal long-term capital gains tax rate for real property is 20 percent, but it’s 28 percent for tangible personal property.

  • Add state income tax and the loss of itemized deductions for most tax payers, selling collectibles just got much more onerous….but you still have options.

 

The landmark 2017 Tax Cut and Jobs Act contains sweeping changes to the entire tax system. Corporate, personal and estate taxes have been revamped entirely. Taxpayers and their CPAs are scrambling to adapt to the new rules. Simply understanding the changes and working through the variations of scenarios as they play out is a monumental chore. One important change that’s not attracting much attention, despite its potentially significant impact, are the revisions to §1031. This code section refers to “like kind” exchanges of property.

Essentially, a properly executed §1031 exchange allowed a property owner to defer the recognition of a gain until the property that it was exchanged for was ultimately sold. For many investors, like kind exchanges have been a very smart method for swapping their way to significant gains by delaying the taxes the owe. In the past, like kind included both real property and personal property. While the majority of the value of §1031 exchanges were in real property, those who collect valuable assets such as fine art, collector automobiles and antiques also utilized the §1031 exchange to enhance their collections. And, while the Federal long-term capital gains tax rate for real property is 20 percent, for tangible personal property it is 28 percent. Add state income tax and the loss of itemized deductions for most tax payers, selling collectibles just got much more onerous.

What can collectors do?

Certainly, collectors are passionate about their collections and often buy or sell in the heat of the moment. While this may be necessary at times, there are still planning considerations that can be implemented, especially before a planned sale. First, there are several charitable techniques that could be considered. One option is a Flip Charitable Remainder Unitrust (Flip CRT). With this technique, the owner creates a special trust and transfers his or her collectible to the trust prior to any sales transaction taking place. The trust then sells the asset and receives cash from the sale. At the time of the sale the donor will receive a charitable income tax deduction based on a number of factors: The donor’s age, the payout rate of the trust, the cost basis of the asset transferred and several other technical factors.

Note, with personal property donated to these types of trusts the income tax charitable deduction is limited by what the owner paid for the item (cost basis) [  }not its fair market value (what it sells for). Further, the deduction for personal property is limited to 30 percent of the donor’s Adjusted Gross Income (AGI) in any given year. However, any unused deduction is available to be carried over for five additional years until it is fully utilized. In this transfer, there is no capital gains tax realized at the time of the sale. However, the donor no longer has access to the cash or the asset but rather will receive and income stream for life based on the what the property sold for and how the trust payout is structured.

Yet another opportunity for tax savings is the “young” Pooled Income Fund (PIF). Similar to the aforementioned Flip CRT, a PIF is a vehicle for avoiding the capital gains tax on the sale of personal property while creating a charitable income tax deduction. Unlike the Flip CRT, the PIF must be established and maintained by a public charity recognized under §501(c )(3). So, it is important to identify the charity that will cooperate with this complexity. One of the major advantages of the PIF strategy is the size of the charitable income tax deduction, which in most cases is many times larger than can be accomplished via a CRT.

The reasons for this are many and unnecessary to explain here. Just know that since the deduction is likely to be much larger, there is more planning flexibility. Consider, for example, that it might be possible to contribute only 50 percent of the asset or less, and still receive enough deduction to make it worthy of consideration. Indeed, with good planning, it may be possible to leave an income stream for the next generation after the donor is deceased--all while avoiding the long term capital gains tax completely.

Ultimately, money left in the CRT or the PIF will transfer to charity, so make sure you and your advisor do some analysis before entering into either of these arrangements. An additional, non-charitable strategy is the monetized installment sale. While not widely known, a monetized installment sale allows the seller to sell and defer taxes for 30 years while receiving more than 90 percent of the sales proceeds. Unlike the aforementioned charitable strategies, the monetized installment sale can take place even after an agreement to sell has been negotiated and agreed to--something that’s prohibited with charitable planning. And while there is no income tax deduction available, the seller does retain the funds for personal use.


Conclusion

While changes in the rules for personal property under §1031 will limit many collectors, they don’t mean that all sellers will now have to realize tax on sales. For those who own their collectibles for more than a year, the long term capital gains tax can be deferred or eliminated. To do so simply requires different planning and well informed advisors.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Withdrawal Strategies: Tax-Efficient Withdrawal Sequence

Key Takeaways:

  • Retirees’ portfolios may last longer if they incur the least amount of income tax possible over their retirement period.

  • Retirees should focus on minimizing the government’s share of their tax-deferred accounts.

  • Make sure your advisor is helping you select the appropriate dollar amount and the appropriate assets to liquidate in order to fund your retirement lifestyle.

Asset Placement Decision

A winning investment strategy is about much more than choosing the asset allocation that will provide the greatest chance of achieving one’s financial goals. It also involves what is called the asset location decision. Academic literature on asset location commonly suggests that investors should place their highly taxed assets, such as bonds and REITs, in tax-deferred accounts and place their tax-preferred assets, such as stocks, in taxable accounts.

In general, your most tax-efficient equities should be held in taxable accounts whenever possible. Holding them in tax-deferred accounts can result in the following disadvantages:

  • The potential for favorable capital gains treatment is lost.

  • The possibility of a step-up in basis at death for income tax purposes is lost.

  • For foreign equities, foreign tax credit is lost.

  • The potential to perform tax-loss harvesting is lost.

  • The potential to donate appreciated shares to charities and avoid taxation is lost.

Asset location decisions can benefit both your asset accumulation phase and retirement withdrawal phase. During the withdrawal phase, the decision about where to remove assets in order to fund your lifestyle should be combined with a plan to avoid income-tax-bracket creeping. This will ensure that your financial portfolio can last as long as possible.

Tax-Efficient Withdrawal Sequence

Baylor University Professor, William Reichenstein, PhD, CFA wrote a landmark paper in 2008 that’s still highly relevant today. It’s called: Tax-Efficient Sequencing of Accounts to Tap in Retirement. It’s fairly technical, but it provides some answers about the most income-tax-efficient withdrawal sequence to fund retirement that are still valid today. According to Reichenstein, “Returns on funds held in Roth IRAs and traditional IRAs grow effectively tax exempt, while funds held in taxable accounts are usually taxed at a positive effective tax rate.”

Reichenstein also noted that only part of a traditional IRA’s principal belongs to the investor. The IRS “owns” the remaining portion, so the goal is to minimize the government’s share, he argued.

Tax-Efficient Withdrawal Sequence Checklist

In our experience, retirees should combine the goal of preventing income-tax-bracket creeping over their retirement years with the goal of minimizing the government’s share of tax-deferred accounts.

To achieve this goal, the dollar amount of non-portfolio sources of income that are required to be reported in the retiree’s income tax return must be understood. These income sources can include defined-benefit plan proceeds, employee deferred income, rental income, business income and required minimum distribution from tax-deferred accounts. Reporting this income, less income tax deductions, is the starting point of the retiree’s income tax bracket before withdrawal-strategy planning.

The balance of the retiree’s lifestyle should be funded from his or her portfolio assets by managing tax-bracket creeping and by lowering the government ownership of the tax-deferred accounts. The following checklist can assist the retiree in achieving this goal:

  1. Avoid future bracket creeping by filling up the lower (10% and 12%) income tax brackets by adding income from the retiree’s tax-deferred accounts.

  2. If the retiree has sufficient cash flow to fund lifestyle expenses but needs additional income, convert traditional IRAs into Roth IRAs to avoid tax-bracket creeping in the future. This will also allow heirs to avoid income taxes on the inherited account balance.

  3. Locate bonds in traditional IRAs rather than in taxable accounts. This will reduce the annual reporting of taxable interest income on the tax return.

  4. Manage the income taxation of Social Security benefits by understanding the amount of reportable income based on the retiree’s adjusted gross income level.

  5. Liquidate high-basis securities rather than low-basis securities to fund the lifestyle for a retiree who needs cash but is sensitive to additional taxable income.

  6. Aggressively create capital losses when the opportunity occurs to carry forward to future years to offset future capital gains.

  7. Allow the compounding of tax-free growth in Roth IRAs by deferring distributions from these accounts.

  8. Consider a distribution from a Roth for a year in which cash is needed but the retiree is in a high income tax bracket.

  9. Consider funding charitable gifts by transferring assets from a traditional IRA directly to the charity. This avoids the ordinary income on the IRA growth.

  10. Consider funding charitable gifts by selecting low-basis securities out of the taxable accounts in lieu of cash. This avoids capital gains on the growth.

  11. Manage capital gains in taxable accounts by avoiding short-term gains.

Conclusion

You and your advisor should work together closely to make prudent, tax-efficient withdrawal decisions to ensure your money lasts throughout your retirement years. Contact us any time if you have questions about your retirement funding plans or important changes in your life circumstances.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.