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January 23, 2012

Tax Planning for Life Events - Highly Appreciated Assets

Sell an asset for profit and you'll pay capital gains taxes, right? Maybe.

As you move your token along the tax-game board called Find the Money, you land on the space labeled “Sell a highly appreciated asset.” Nice. There’s a lump sum of cash coming your way. But hold it there, Rockefeller – you only get to keep what’s left after taxes.

The things you own and use for personal and investment purposes are considered capital assets by the IRS. These include your home, collectibles, and stocks & bonds. If you sell a capital asset for more than you paid for it, you realize a capital gain. When you realize a capital gain, you’ll pay a capital gains tax. The tax you pay will be either a higher short-term rate for a one-year holding period or a lower long-term rate if you’ve owned the asset twelve months or more.

So, if you recently parted with the beach house you bought in 1966 and banked the cash, you’ll pay a 15% long-term capital gains tax. If you also sold the Warhol you bought for the housewarming, you’ll pay 28% in long-term capital gains tax since art & collectibles fetch a higher rate. Or if you sold the El Paso Corp (EP) stock yesterday at $27 per share that you bought last October at $18, you’ll pay income tax rates on the short-term gain.

I like a profit – but that’s a lot of taxes. Isn’t there a better way?

Glad you asked. There are other trails on the game board you might take before landing to the space labeled “Write a check payable to IRS.” Consider these options:

Throw down a net
Since the tax you pay will be based on your net capital gain, you can reduce your gain dollar-for-dollar with an offsetting loss. For example, you remember you bought shares in First Solar Inc (FSLR) last July at $132 because everyone’s gonna make millions in green technology. Now the stock is trading at $38 per share. I know – “Ooouuch.” But make lemonade from that lemon.

If you offset a $95,000 gain in EP with an $80,000 loss in FSLR, you’ll be left with only a $15k net short-term capital gain – and a lower tax. But what if you lost $120k in FSLR? (What were you thinking?) Now you can make lots of lemonade since you can realize a net $0 capital gain this year, reduce your income by $3k on your tax return, and carry forward a $22k loss for the future.

Be a Giver with a Charitable Trust
The win-win nature of a charitable strategy makes sense for many middle class Americans. If you own highly appreciated stock, art, or real estate that your family won’t need in the future, you can give the assets away and make some powerful things happen.

Life income
Setting up a charitable remainder trust (CRT) and funding it with highly appreciated wealth means it will pay you income for the rest of your life before passing to charity when you die.

Since you retain control of your gifted assets, you can add, change, or remove charities from your trust at any time. Also, you may choose to inform the recipients about your gift in advance or reveal it after you’re gone.

Get by giving
Creating a CRT has a positive impact all around:

  • Get rid of a capital gains tax
  • Get income for life
  • Get a charitable tax deduction
  • Get assets out of your taxable estate
  • Give resources to a worthwhile cause

Some or all of these ideas may be financially savvy for you depending on your situation and how you play the game.  But you need to work that game board. That’s why it’s called Find the Money

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