by Tom McGirr
Let’s say you have some highly appreciated assets you would like to sell. Maybe it is a block of stock that, due to appreciation, represents a disproportionate percentage of your portfolio. It makes sense to sell and diversify so as to increase return and reduce risk. Perhaps it is a parcel of real estate that has fully depreciated. While you could try to put together a tax-free exchange, you really would like to get out of the property management business altogether. Or, perhaps you are finally ready to sell your business and retire.
What is holding you back? If you are like many other people, it is the impact of capital gains taxes. If you sell, Uncle Sam is going to take a big chunk of your sale proceeds. The IRS will tax those gains as high as 20%. If you live in Oregon, the state will tack on an additional 11%, while Idaho will ask for somewhere between 3.1 – 7.8%! It’s no wonder that so many people hang on to assets that they would really rather sell: Paying all those taxes could certainly impact your retirement plans!
Is There a Solution?
A Charitable Remainder Unitrust may be the perfect solution. Here’s how it works and some of the benefits you can expect to receive:
1. Gifting the Asset: You gift the asset (or a portion thereof) you want to sell to a special kind of charitable trust for the benefit of your favorite charity. Because the assets will eventually pass to 503(c) tax-exempt charities (which do not pay income taxes), the assets can be sold by the trustee without incurring capital gains. The trustee retains 100% of the sale proceeds to reinvest on your behalf.
2. Retaining an Income Stream: You can retain an income stream for either a set term of years or your lifetime. The amount of income is based on a percentage of the trust principal, valued annually. For example, if the trust is worth $1 million, and you specified a 5% payout, you would receive $50,000/year.
The payment amount can be fixed or, if you elect the Unitrust option, as the trust principal increases in value, so does the income stream. Because the trustee has more funds to work with from the very beginning, and the funds are professionally managed, it can often generate a bigger income flow than you would have been able to do with the after-tax sale proceeds.
When selling real estate or a business interest that represents a majority of your net worth, you might consider gifting a percentage of that asset to the charitable trust. For example, you might gift up to a 49% interest to the trust while retaining 51%. This way, you control the terms of sale and retain ample funds in your own name to do with as you wish.
3. Receiving a Tax Deduction: Another benefit is the income tax deduction you receive when you make the gift to the trust. Because the charities will not actually receive the assets until your income stream expires, you cannot deduct the entire value of the gift. Rather, the deduction is reduced to reflect that fact that the charity will not receive funds until your income interest expires.
However, for older donors choosing a 5%-7% payout, the deduction can be very significant. In the above example, the federal charitable deduction for a couple ages 65 and 66, retaining a 5% income stream for life would be $334,500. Assuming a 7% return for the trust, lifetime distributions to them could be as high as $1,353,000 based on current life expectancy tables.
That tax deduction can be applied against current income to lower income taxes within certain IRS limitations. If you cannot use the deduction in its entirety during the year of the gift, the balance can be carried forward. Another alternative is to view the deduction as creating an opportunity to further diversify your personal investment portfolio. The deduction can be used to offset capital gains realized when selling other assets.
Almost everyone is happy to this point: You have a way to sell an asset without paying current capital gains, you have an income stream for life, you are helping your favorite charities and getting a tax deduction to boot. Then someone asks “But what about your heirs?”
At some point, the trust is going to distribute the assets to charity (that’s why it is called a charitable trust). If you feel the heirs are not receiving enough other assets, you might want to consider a “Wealth Replacement Trust.” This special trust, funded with life insurance, can replace all or part of the funds going to charity. The cost of funding the insurance trust can come from part of the extra income you are now receiving from the charitable trust or as a result of the income tax deduction you received. Moreover, if done correctly, the proceeds from the wealth replacement trust will pass to your heirs’ estate and income tax free!
There are some benefits to considering setting up your own charitable trust in lieu of a community foundation or trust run by a charity. Some foundations require you to set aside 50% or more to go to their entity upon death. If you wish to benefit multiple charities or do not want to give that much to one charity, this could present a problem. Likewise, many donors want to be able to have some say over who is investing their funds. Creating your own charitable trust and selecting Columbia Bank Trust and Investment Services as the trustee gives you the freedom to give assets to whomever you wish and insures your funds are invested by a firm you know and trust.
While not appropriate for everyone, the Charitable Remainder Unitrust can provide some important benefits in the right circumstances. It is important to remember that the charitable trust must be in place BEFORE you have entered into a sales agreement. For more information, contact Columbia Bank and ask to speak with a trust specialist. You should always consult your tax advisor to ascertain the tax implications of any gifting program.
Thomas McGirr, JD, CTFA is Certified Trust and Financial Advisor with Columbia Trust and Investment Services. He can be contacted at 503-399-2901 or via email: firstname.lastname@example.org
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