Unfortunately, higher capital gains taxes appear to be almost a certainty in the near future. Why? Because President Biden’s $3.5 trillion American Families Plan, if passed by Congress, will raise the long-term capital gains rate from its current 20% to 39.6% if you earn more than $1 million per year.
Keep in mind that the federal capital gains tax is only the first of three taxes that you face paying when you sell a highly appreciated asset. Most states have their own capital gains taxes, which range from a low of 2.9% in North Dakota to a high of 5.75% in California. Then there’s the 3.8% net investment income tax if your modified adjusted gross income exceeds $250,000 (married, filing jointly) or $200,000 (single). Taken together, your capital gains tax liability could amount to as much as 49.15% of your gain.
While most experts agree that it’s probably too early to take diversionary action regarding the sale of your highly appreciated assets since the actual new federal capital gains tax rate is still up in the air, they stress that it’s definitely not too early to begin planning so you’ll be prepared to initiate your plan no matter what laws Congress ultimately pass.
Enter the Deferred Sales Trust
If you currently hold substantial highly appreciated assets, you should consider utilizing the Deferred Sales Trust (DST). This safe, legal, tested and proven strategy allows you to defer and lower the capital gains taxes you face when selling one or more of them. The DST works equally well for any of the following types of sales:
- Investment real estate
- Small business
- Personal residence
- Investment portfolio
- Personal property, such as art works, antiques, etc.
Deferred Sales Trust Versus Delaware Statutory Trust
Be aware that two types of DSTs exist: the true Deferred Sales Trust and the Delaware Statutory Trust. They are quite different in nature and effect. The biggest difference is that you can only use a Delaware Statutory Trust when you sell real estate that’s compatible with 1031 exchange property. Conversely, you can use the true DST when selling any type of of highly appreciated asset. In fact, the true DST makes an excellent 1031 exchange alternative since it relieves you of the necessity to reinvest in like-kind property, designate your replacement property within 45 days and complete your sale within 180 days. By the way, the American Families Plan also calls for elimination of 1031 exchanges altogether.
The true DST offers you additional benefits as well, including the following:
- Virtually unlimited capital gains deferral
- Ability to pay eventual capital gains taxes in increments at reduced rates and with inflated dollars
- Ability to reinvest in any “prudent investment,” such as stocks, bonds, commodities, annuities, REITs or even life insurance
- Maintenance and growth of your family wealth
- Possibility of accomplishing an estate tax freeze
- Probate avoidance
- Receipt of retirement income if, when and how you want it
Begin Planning Now: Should I sell before any tax hike plan is passed?
Many people are resigned to the expectation that taxes are shortly to be increased and wonder if it makes sense to accelerate their sale before the end of 2021 to try to pay their taxes at a rate lower that what might be expected in the future. But hold on. . . if you read the tax proposal carefully, the administration is pushing hard for a retroactive effective date back to April 13 of 2021. If enacted and you sell after that date, you will not be grandfathered in. Lets face it, even the current tax rates are too high, but for many it seems like the lesser of two evils compared to what they expect to come.
What if we were to tell you that if you use the Deferred Sales Trust to sell your appreciated asset, it doesn’t really matter what the capital gains rate is. . . .because most you wont pay it or if you do it will be many years down the road and there could be another administration that restores sanity to the reasonable tax approach to capital gain?
Let me explain. While not a requirement, most DST clients choose to only receive partial or full interest only payments on their sales proceeds and preserve their principal. If you are similarly inclined, yes you would pay taxes on the interest payments you receive from the trust but you would pay NO capital gains taxes unless you draw from the principal after maximizing distributions from the interest portion. In this way you can engineer how and when you pay taxes. For example you might have tax losses and can therefore take principal payments to offset them, or a new administration may reduce the capital gains rates in the future allowing you to reconsider how you withdraw from your DST. In the meantime you are still earning attractive personal returns on money you otherwise would have paid in taxes in the year of sale.
In these uncertain times, the experts are right: it’s not too early to begin planning for the upcoming capital gains tax rate hike. Request a free Reef Point consultation today. We’ll be happy to answer all your DST questions and explain how using this strategy can benefit your specific situation.