Capital gains tax is levied on investments and real estate when the investor sells them after holding them for a year. Capital gains tax is charged on the profit made by selling the asset at income tax rates, just like your regular income. The tax rate could be anywhere from 0% to 20% depending on your annual income and filing status.
Estate tax on the other hand is paid when after the property is transferred to your heirs after your death. However, not all inherited assets are liable to be taxed by the federal government.
Both capital gains taxes and estate taxes can cost a bomb to an average American taxpayer. Fortunately, there are some steps you can take to minimize the amount of tax you owe to the Government on capital gains and estate transfer.
Charitable Remainder Trusts
If you want to defer paying capital gains tax on profits made by selling assets, Charitable Remainder Trusts are the best way to do so. For this, you must transfer the assets into a trust before they are sold to generate income over a certain period. You are essentially putting a high-value asset into an irrevocable trust when opting for the Charitable Remainder Annuity Trust.
As a donor, you will retain a fixed payment of principal and interest (annuity) from this trust for a said number of years. The duration may be up to 20 years or until the death of the non-charitable beneficiary. After the aforementioned tenure of payments is over, the balance in the trust is received by a registered charitable organization of your choice.
Donations to a Charitable Remainder Annuity Trust are eligible for income tax and gift tax charitable deductions. The beneficiary of the Trust will receive a specified amount each year for a stipulated duration. The amount will be a fraction or percentage of the fair market value of the asset in the Trust.
The non-charitable beneficiary can also claim an income tax deduction on the present value of the remainder interest in the Trust that will be passed on to a charitable organization. The amount eligible for income tax deduction is calculated by deducting the present value of the annuity from the fair market value of the asset in the trust. The remainder value can be deducted while putting the asset in the said Trust.
Charitable Lead Trusts
If you want to offset up to 50% of your Adjusted Gross income, setting up a Charitable Lead Trust is your best shot. You may also use it to eliminate gift tax or estate tax when passing on the asset to your heirs or other beneficiaries. One can create a Charitable Lead Trust by adding assets into an irrevocable trust. A charitable organization of your choice will receive a fixed principal amount and interest (annuity) for a specific number of years as specified by you. At the end of this term, all the assets in the trust will be transferred to the beneficiary as mentioned by you.
As a result, you will be eligible to claim a huge income tax deduction. A Charitable Lead Trust can be created at any point in life and is highly recommended to save tax on appreciated assets. A Charitable Lead Trust works conversely to a Charitable Remainder Trust. In a Charitable Remainder Trust, the remainder of the assets are transferred to a charity; whereas in a Charitable Lead Trust, the payout to charities is made at the beginning of the term.
Qualified Opportunity Zone Funds
Although a new tactic in the play but a game-changer, Qualified Opportunity Zone funds can help you get a tax-free return on your investment and also help defer the capital gains. The Opportunity Zone Program under the 2017 Tax Cuts and Jobs Act provides tax benefits to distressed communities on investments in Qualified Opportunity Zone Funds.
A Qualified Opportunity Fund is a passive investment fund that invests a major chunk of its capital in new opportunities. Those investing in the Quality Opportunity Funds get a tax deferral for five to seven years on the capital gains made amidst other tax benefits. What’s more, an investment in a Qualified Opportunity Fund for more than 10 years can be cashed out tax-free!
Deferred Sale Trust
Investors can also sell a highly appreciated asset to a Trust for an installment note in return. The Trust will ultimately sell that asset to a third party and you will end up paying taxes only on the gains and interest paid to you by the Trust. The Trust will not pay any tax on the sale and reinvest the proceeds into another asset for the beneficiary of the Trust.
Individuals with highly appreciated assets amounting to more than $3.5 million must make the best of these tactics to save every extra penny on taxes. Of course, each of these Trusts and Funds has a shortfall and an added advantage. Taxpayers must be wary of the do’s and don’ts when opting for these strategies. Speak to a professional tax advisor for a better understanding of these programs at C19grants@mytaxfiler.com