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
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.
The trust then sells the asset tax free and receives cash from the sale.
At the time of the sale the donor will receive a partial charitable income tax deduction based on a number of factors:
the donors age,
the payout rate of the trust,
the cost basis of the asset transferred
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.