Would you like to sell appreciated real estate without paying a dime in capital gains tax? In fact, you do not have to purchase replacement real estate with the sale proceeds and all of the future gains from your new investment will be tax FREE. Rather than paying any tax you will actually receive an income tax deduction. Does it sound too good to be true? The strategy is a Charitable Remainder Trust, “CRT”. If you have never heard of this tool count yourself among the vast majority of real estate investors whose local professionals only know of 1031 tax deferral strategies for real estate investments. Tax deferral is great, but TAX FREE is much better and this is where we Chicago CPA come into picture to help you save taxes
A CRT is a specific type of trust specifically authorized under federal tax law. Like all trusts, a CRT has four players; the grantor (the person who contributes assets to the trust, a trustee (the person who controls the assets held within the trust), an income beneficiary (the person or persons entitled to the income generated by the trust), and the remainder beneficiary(ies) (the person or in this instance, the charitable organizations entitled to receive the trust assets when the income beneficiary dies or after a set term of years). Alright, if the last party to the trust, i.e., the remainder beneficiary being a charity, then it should shed some light on how this type of trust received its name. Unlike a living trust that distributes it assets to family members when you pass away, a CRT must distribute any undistributed assets to one or more charities of your choosing
If you are inclined to stop reading now because you are of the opinion that charity starts at home then you are missing out on one of the greatest tax benefits still available under the tax code. Believe in our accounting bookkeeping services when we say you want the charitable beneficiary. It is the requirement you name a charitable beneficiary that will produce phenomenal tax planning opportunities. Consider the following benefits:
1. When you transfer an asset into the trust you will receive an immediate income tax deduction for 10% of the assets value;
2. Appreciated assets contributed to the trust can be disposed of tax free;
3. All future gains generated inside of the trust are tax free to the trust; and
4. All the income generated by these assets when paid out
Consider Thomas who is looking to sell a commercial property he has owned for many years. After consulting with his income tax preparer, Thomas was given the following numbers regarding the tax consequences of this sale:
Original Basis $550,000
Taxable LTCG $650,000
Depreciation Recapture $450,000
Tax Liability ($450,000 x 25%) + ($650,000 x 20%) = $242,500
Thomas considered a 1031 exchange to avoid taxes but a recent investment opportunity in an oil and gas venture has Thomas reconsidering his options. If Thomas sells his property and invests in the oil and gas venture he will not be able to take advantage of the favorable 1031 exchange rules because oil and gas is not a like kind investment.
The ideal recommendation to Thomas from we, Chicago CPA was to form a Charitable Remainder Trust. We will establish the trust with Thomas as the trustee, he and his wife as the income beneficiaries (they will receive an income stream from the trust for life) and a private foundation as the remainder charitable beneficiary (more on this later). When Thomas deeds the property into the trust Thomas will immediately receive a $120,000 income tax deduction. Given Thomas’s personal income tax bracket of 39.6%, his tax deduction will save him $47,520 in taxes. Further, when the property is later sold Thomas will save an additional $242,500 in taxes and have the full $1,200,000 million to reinvest in his oil and gas venture.
This financial situation could not get any better until he could make his future income from the trust completely tax free. If you recall, a CRT is designed to pay you an income stream for life or a period of years. What is so exciting about this trust is you are in control. Control is not just how the trust assets are invested, but control when the trust begins paying you out income and how that income is taxed upon receipt. Basically, you become Uncle Sam.
When Thomas was ready to begin receiving income, our accounting bookkeeping services will make some adjustments to his investments so the income generated by the trust is non-taxable. This is the income we will distribute to Thomas thus, turning what would have been a taxable event when he sold his real estate and all future gains into a completely tax free endeavor.
Thomas’s final concern was the distribution to the charity when he and his wife pass away. Thomas wondered if there was anyway his kids might benefit. Funny he should ask because it just so happens Thomas’s CRT could morph into a private foundation run by his children. His two kids, in exchange for running the foundation, could draw a salary. The only requirement on the children would be they give away 5% of the foundation’s assets annually.
In the meantime, are you still stuck paying traditional income taxes and wishing you could pay less? The best way to do that is to make a plan. It is the refund season now, call us on 773-728-1500 for your plan!