The Tax Cut and Jobs Act that went into effect on January 1st of 2018 contains sweeping changes to the entire tax system. Corporate, personal and estate taxes have been revamped entirely and practitioners are scrambling to adapt to the new regime and to provide the “right” advice for their clients. Simply understanding the changes to the tax for individual taxpayers and working through the variations of scenarios as they play out, is a monumental chore. One of the little discussed areas of change that will affect many individuals are the revisions to §1031. This code section refers to “like kind” exchanges of property.

Essentially, a properly executed §1031 exchange previously allowed an owner to defer the recognition of gain until the property that was exchanged for was ultimately sold. For many investors, this has been a method for swapping their way to significant gains by delaying the taxes due. In the past, like kind included both real 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%, for tangible personal property it is 28%. 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.: Solution #1

  1. One option would be a Flip Charitable Remainder Unitrust (Flip CRUT). With this technique, the owner has a special trust created and transfers his collectible to the trust prior to any sales transaction taking place.

  2. The trust then sells the asset tax free and receives cash from the sale.

  3. At the time of the sale the donor will receive a partial charitable income tax deduction based on a number of factors:

  4. the donors age,

  5. the payout rate of the trust,

  6. the cost basis of the asset transferred

  7. and a couple of other technical factors. Note:, that with when personal property is donated to these types of trusts, that 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% of the donor’s Adjusted Gross Income (AGI) in any given year. However, the unused deduction is available to be carried over for five additional years until fully utilized.

In this transfer, there is no capital gains tax realized at the time of the sale because it is sold by the tax exempt charitable trust.. However, the donor no longer has access to the cash or the asset because it is owned by the trust, but rather will receive an income tax deduction for a portion of the asset transferred and an income stream for life based on the what value of the property sold for and how the trust payout is structureddefined in the trust.

Solution #2 Yet another opportunity for tax savings is the “young” Pooled Income Fund. Similar to the aforementioned Flip CRT, The PIF provides a means of avoiding the capital gains tax on the sale of personal property while creating a charitable income tax deduction. Major differences between the Flip CRT include the fact the PIF must be established and maintained by a public charity recognized under §501(c )(3), so it is important to identify the charity who will cooperate with this complexity.

One of the major advantages of the PIF strategy is size of the charitable income tax deduction, which in most cases will be multiples greater than can be accomplished with the CRT. The reasons for this are many and unnecessary to explain here but because 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% 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 totally avoiding the long term capital gains tax. Ultimately, money left in the CRUT or the PIF will transfer to charity so careful analysis should be undertaken before entering into either of these arrangements. There are very few advisors who are familiar with these strategies but finding those who are qualified may be worth hundreds of thousands of dollars or more.

Solution #3 An additional, non-charitable strategy is the installment sale. Widely understood, in its normal form, there are a few variations that make itI more enticing. One unique technique allows the seller to sell and defer taxes for thirty years while receiving more than 90% of the sales proceeds immediately. Unlike the charitable strategies, the transaction 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.

In Summary While the changes in the rules for personal property under §1031 will limit many collectors, they don’t mean the all sellers will now have to realize tax on sale. For those who own their collectible 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.

One of the many ways to explore the charitable leanings of a client is to find out what they care about in the world. An easy entry into the conversation is to ask where they volunteer their time. True that parents often volunteer to coach their kids’ teams or serve on the PTA at their schools but above and beyond that, there is likely to emerge a pattern of giving time that will lead to a larger pattern of giving money and can open the conversation about more substantial gifts.

In their recent survey of High Net Worth (HNW) donors, U. S. Trust determined that 75.1% of the HNW volunteered and of those that volunteered, 34.3% volunteered more than 200 hours per year. Simple math makes that four hours per week, probably one good shift of hands on work each and every week of the year. It shouldn’t take a rocket scientist planner to think about asking questions about volunteer activities and the source of the passion about the cause and the potential of leaving a large planned gift to the cause that they are supporting with their time and talents.

Charities have known for a long time and a number of studies bear out that people tend to give more where they volunteer. What is often overlooked is that those who make planned gifts tend to volunteer more and give more current gifts as well. If you think about it for a minute, it makes perfect sense. After all, if you intend to make a large gift at your death or sometime in the future, you are going to want the organization to be in existence and to be fulfilling its mission capably at the time they receive the gift. In order for that to happen, volunteering time to provide guidance and to observe how the mission is being carried out is a logical progression in the giving process.

Advisors interested in charitable giving and planned giving should consider doing their own volunteer work. Not for the purpose of prospecting, of course. But for the purpose of understanding what it’s like to be involved at some level of the giving experience. Not only will it help you to speak the language it will help you to feel the feeling of supporting some cause that you believe in. Unearthing your own passions about giving will certainly enable to understand and communicate with your clients at a deeper, more meaningful level.

One of the major disconnects in the U. S. Trust survey on philanthropy was that donors (clients) felt that their advisor didn’t bring up the subject often enough, soon enough or in anything other than the description of a tactic or tactics. What donors really want, according to the survey, is for their advisor to help them discover their passionate causes. Leading donors through a volunteering discussion, sharing your own experiences or discussing theirs will provide access to new conversations and a greater depth of understanding of who your client is and what they care about. After that, the tactical part is easy.

For many Americans the new tax act, now known as TCJA 2017, means they will no longer itemize their tax deductions. While this may make their tax filing simpler, it also means that giving money to charity will no longer be tax deductible. And, while surveys indicate that we Americans don’t give because of the tax savings, there is a consensus that giving will drop precipitously. Some estimates I’ve seen suggest that annual giving will drop by $30 Billion. With 1.5 Million charities fighting for every donation possible, this could mark a tremendous upheaval in the non-profit world. While it should take one or two tax years before anyone really knows what the impact is and how the giving populous has adjusted, charities and advisors ought to be prepared with solutions to help their donors regain the confidence to keep giving and to save taxes, if possible.

Many of the traditional planned giving vehicles fill the bill, of course. Charitable Remainder Trusts, Charitable Lead Trusts, Pooled Income Funds and Gift annuities all should be considered and reviewed on behalf of any donor or client trying to find a way to continue to give. The charitable IRA rollover also deserves more attention for those that are over age 70 ½. While these solutions will be applicable to some, it may be a good idea to think a little differently now.

One interesting idea to add to the charitable planning arsenal is actually nothing new but an adaptation of a long-accepted tool: the non-grantor trust. Non-grantor trusts are a traditional estate planning vehicle, often used to move assets outside of the taxable estate for the benefit of the next generation. The “non-grantor” status means that the trust pays income tax on its earnings based on trust tax rates. Taxable trusts pay tax at a higher rate sooner than individuals do so it would seem counter-intuitive to suggest that this type of trust would be of benefit. However, income that is distributed to a beneficiary is generally deductible to the trust and taxed at the beneficiary’s income tax rate. Thus, if the beneficiary is a charity, the charity’s tax rate is zero.

Here’s an example: Client who regularly gives $5-10,000 year to his charities of choice sets up a non-grantor trust that allows him to give money to charity and also naming his children as discretionary beneficiaries. He transfers $250,000 of cash, files a gift tax return, using part of his lifetime gifting exemption of $11.2 million. He invests the $250,000 is a high dividend portfolio that should produce 2-4% per year of income. At the end of year one there is $7,500 of dividend income which he directs the trustee to give to his favorite charity. The trust sends 100% of the dividends out to charity and has zero taxable income. The client has no tax on the earnings of the trust and since he gifted it away, it is no longer appearing on his personal return, effectively saving him state and federal tax on $7,500 of income. That’s essentially the same as a $7,500 income tax charitable deduction that may no longer be available to him. Voilà, we have worked tax planning magic.

While this may seem complex, it’s really quite simple to accomplish and may work for a significant population of donors. New laws present new challenges and new opportunities. As advisors, it’s our responsibility to help our clients achieve their ideal outcomes. Learning new applications of old tools is just another way to add value for our clients.

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