Why Delaware Statutory Trusts (DSTs) Make Popular Real Estate Tax Deferral Solutions

Real estate can be a powerful asset to build your wealth and provide financial independence.  However, there may come a time when the “Three T’s” of real estate investing – Tenants, Trash, and Toilets – becomes old. While selling and sailing off into the sunset can appear alluring, the thought of settling up with the taxman can throw cold water onto the face of that dream. Fortunately, the tax code provides savvy real estate investors several options to sell, defer or eliminate capital gain taxes and maintain an income stream.  A few possibilities include Delaware Statutory Trusts, Qualified Opportunity Funds, and Charitable Remainder Trusts.

In this article, we will explore Delaware Statutory Trusts (DSTs). DSTs can allow an accredited investor to say adios to the Three T’s while also putting off, and potentially eliminating, the unpleasant notion of settling with Uncle Sam.

WHAT IS A DELAWARE STATUTORY TRUST?

A Delaware Statutory Trust is an investment trust that you can use for real estate ownership of high-quality, professionally managed commercial properties that provide a passive, turn-key solution for completing a 1031 Exchange.

Investors in a DST are not direct owners of real estate.  Instead, they own an undivided interest in the assets held by the trust.

The Delaware Statutory Trust holds title to the property for the benefit of the investors.  Each DST is established and managed by a “sponsor.” 

DSTs QUALIFY AS A 1031 LIKE-KIND EXCHANGE

The 1031 “like-kind” Exchange allows a real estate owner to defer capital gains (and depreciation recapture) taxes on a property sale when they use the proceeds to reinvest in qualifying properties.  If exchanging into direct ownership of another property, you defer the taxes, but the Three T’s remain the investor’s responsibility.  

The IRS recognizes Delaware Statutory Trusts as qualified replacement property for a 1031 Exchange.  By owning an undivided interest in the trust assets, the investor can enjoy the benefits of real estate ownership without the hassles of being a landlord.

OTHER ADVANTAGES OF DELAWARE STATUTORY TRUSTS OVER DIRECT PROPERTY OWNERSHIP

Institutional Quality Real Estate. DST’s allow real estate investors access to large, high-quality commercial properties that may otherwise be out of their reach. Partnering with a respected sponsor with better access to institutional quality properties and expertise in property management can help you expand your options when looking for replacement property.   

Diversification. Diversification helps to minimize risk in your investment portfolio. Many real estate investors tend to focus on one asset class, such as multi-family properties.  Delaware Statutory Trusts provide you the opportunity to own a diversified real estate portfolio (e.g., warehouses, storage, essential retail, etc.).   Additionally, DSTs can help you diversify your real estate portfolio geographically through ownership of quality properties in several areas of the country.  For example, you can sell one property in Chicago, IL, and exchange the proceeds into multiple Delaware Statutory Trusts that own warehouses in Austin, TX, multi-family properties in Denver, CO, essential retail in Nashville, TN, self-storage in Tampa, FL, etc.

Passive Income. Many real estate investors want or need to replace the income stream from their investment property. A DST portfolio can provide you an income from multiple properties that can potentially meet or exceed the net income from the sold property.  Most Delaware Statutory Trusts distribute income monthly.  Passive income without the hassles of direct property ownership can be an attractive exit strategy for property owners. 

Estate Planning Flexibility. You may prefer to manage your real estate property actively. Your spouse or heirs may not know how to take over that responsibility if something happens to you. DSTs can be a powerful estate planning tool because you can divide your interests amongst beneficiaries leaving each to decide what to do with their portion. Furthermore, the cost basis on the properties steps up to fair market value upon your death.

Closing with Confidence. Investors trying to complete a 1031 exchange can face uncertainty when identifying properties for an exchange and closing on the purchase within the required timeframe. Investing in Delaware Statutory Trusts may remove the uncertainty and hassle from the process. The Delaware Statutory Trust sponsor is responsible for doing the heavy lifting involved in setting up and managing the trust. You can close on the purchase of DSTs in short order compared to the time it often takes to close on a direct property purchase.  This allows you to seamlessly transition from selling your property into owning a diversified Delaware Statutory Trust portfolio.

Possible Disadvantages. DSTs are illiquid investments and therefore are only appropriate for long term investment horizons.  A typical DST may be liquidated by a sponsor after 5 to 10 years, and the investor will then have the option to exchange into another qualifying replacement property or to receive cash and pay any taxes due at that time.  Also, Delaware Stutory Trusts are only available for accredited investors.  Please read the disclosure at the end of this article.

Click here to read about other potential benefits of owning DSTs

DSTs can offer accredited investors some unique opportunities.  Under the right circumstances, they can be an effective solution for real estate investors looking to eliminate the dreaded Three T’s of being a landlord while deferring or eliminating taxes, maintaining a rental income stream, and continuing to enjoy the benefits of property ownership.   Consulting with an elite wealth manager who understands the unique needs of real estate investors can help you determine if owning Delaware Statutory Trusts is appropriate for your objectives.

DISCLOSURE & ACKNOWLEDGEMENT

To be an “accredited investor,” an individual must have had earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years and “reasonably expects the same for the current year.” Or, the individual must have a net worth of more than $1 million, either alone or together with a spouse, excluding one’s primary residence

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Family LLC or Family Foundation: How Can My Family Benefit?

Families can use several advanced planning tools to achieve their values, goals, and objectives.  Along with preserving family wealth, many families are interested in reducing taxes, effectively transferring wealth across multiple generations, protecting assets from catastrophic loss, and making impactful charitable gifts.  A Family Limited Liability Corporation (LLC) or a Family Foundation are two worthy options for you to consider.

FAMILY LIMITED LIABILITY CORPORATIONS (FAMILY LLC)

A Family LLC is a legal entity that enjoys the limited liability of a corporation and the operational flexibility of a partnership. Most people who set up Family Limited Liability Corporations are typically larger estates, looking to minimize state and federal estate taxes and avoid paying gift taxes. A Family LLC can benefit from owning rental properties, brokerage accounts, or a family business. Having a Family Limited Liability Corporation can protect your family members from creditors, help with estate planning, and divide income among the members.

You will want to have an operating agreement that limits and defines ownership and transfer rights. Some Family LLC could provide significant discounts from estate and gift tax.

ADVANTAGES OF A FAMILY LLC

One of the main benefits of a Family LLC is that you can transfer a family business with ease to the next generation. A Family Limited Liability Corporation acts as a pass-through for income tax purposes, minimizing federal gift and estate taxes.  

For successful business owners, a Family LLC can reduce income taxes by spreading business income across multiple family members and generations that may be in lower income tax brackets.    

Owners retain control over the assets and can protect younger members from financial decisions.

A Family Limited Liability Corporation can be an excellent vehicle to protect the assets against claims by creditors, divide income among generations, and facilitate multi-generational wealth transfer and estate planning.

DISADVANTAGES OF A FAMILY LLC

You cannot blend personal and business assets in a Family Limited Liability Corporation.

A Family LLC must meet IRS requirements; there could be consequences if you form a Family Limited Liability Corporation only to avoid paying taxes.  Also, the general partners of a Family LLC can be vulnerable to some risk, so it is a good idea to work with an elite wealth manager and a team of experienced and knowledgeable professionals in this area.

The members of the Family LLC pay taxes on their share of the entity’s profits, and there will be initial and annual fees associated.

FAMILY FOUNDATIONS

A Family Foundation, also known as a private foundation, is a not-for-profit organization mainly funded by a person, corporation, or family. The assets within the private foundation will generate income, which is used to support the foundation’s operations and make charitable grants to other nonprofit organizations. In addition, a family foundation can help foster family connections and instill family values for the younger generations.

ADVANTAGES OF A PRIVATE FOUNDATION FOR YOUR FAMILY

A private foundation gives you control over the choice of charitable organizations to which you want to support. In addition, you and your wealth manager can choose how to invest the assets in the foundation.

With a private foundation, succession possibilities are endless. With your family involvement, you will create a legacy and bond as a family around something meaningful.  You can have a clear vision of how you want to make a difference in the world and which causes you to want to support.

Family Foundations provide significant tax benefits.  You can avoid paying capital gain taxes on appreciated assets, including private business shares, public stocks, real estate, etc., by donating the assets to your foundation and then selling.  Since the Private Foundation is a tax-exempt entity, the sale incurs no capital gain tax. 

Additionally, you can claim a significant charitable deduction for the total market value of the assets donated to the Family Foundation, which can help offset taxes on other income sources.  The tax deduction can be carried forward for several years to continue providing tax benefits years after the donation. 

When you transfer assets to a Family Foundation, they are usually not subject to estate taxes; this can provide three types of tax savings combined with the tax benefits described above.

DISADVANTAGES OF A PRIVATE FOUNDATION FOR YOUR FAMILY

Setting up a Family Foundation is time-consuming, and there will be legal, and accounting fees associated with the setup and ongoing maintenance of the foundation.  There are regulatory and other reporting requirements, usually completed by your accountant and attorneys each year.

Assets transferred into a Private Foundation from you are irrevocable. You can’t change your mind once the transfer is complete.

There are annual excise tax payments; most foundations pay a 1 to 2% annual excise tax on their net income. This percent depends on the foundation’s annual grantmaking.

Family Limited Liability Corporations and Family Foundations are two effective strategies to help achieve what’s important to you and your family.  They can help you live a life of significance, accomplish your aspirations, and leave a multi-generational legacy. 

Both of these tools have significant advantages for the right family.  However, both have their share of disadvantages too.  If a Family LLC or a Private Foundation is not a good fit for your situation, there are many other options to consider.  It would be best to consult with your wealth manager and other advisors to determine the best solutions for your circumstances.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Comparing 1031 Exchanges vs. Qualified Opportunity Funds

While both strategies can help real estate investors reduce taxes, there are several differences between a 1031 Exchange and a Qualified Opportunity Fund that you should understand before investing in either method.

100 YEARS OF 1031 EXCHANGE

The 1031 Like-Kind Exchange, also known as 1031 Exchange, has been around for quite some time. Since its inception in 1921, it has become one of the most popular tax strategies used by taxpayers when relinquishing their real estate property. For generations, investors have used 1031 Like-Kind Exchanges to swap investment properties and defer taxable gains.

However, there is now a relatively new option that defers or even potentially eliminates a portion of capital gains for real estate investors. Created under the Tax Cuts and Jobs Act of 2017, the Qualified Opportunity Fund, or QOF, provides taxpayers an alternative way to postpone and eliminate certain taxable gains.

In addition, it allows individuals to invest their capital gains in real estate or business development projects within designated communities known as Qualified Opportunity Zones. Both strategies can be great tools for investors, but there are differences between the two. Let’s go over some of these differences that you should know before investing in either one of these options.

WHAT ASSETS ARE ELIGIBLE FOR EACH STRATEGY?

Only real estate held for investment purposes can qualify for a 1031 Exchange. Personal property is excluded because this specific asset class is not eligible for the exchange written in a set of rules determined by the Internal Revenue Service.

On the other hand, Qualified Opportunity Funds allow for potential capital gain tax deferral on a broader range of eligible assets, including stocks, bonds, real estate, collectibles, partnerships, and private business interests.

Essentially any investment whose sale would result in a taxable capital gain can qualify for a Qualified Opportunity Fund. It is important to note that for both strategies, only the profits accumulated from the disposition of the listed assets are eligible to receive the respective tax benefits of the 1031 Exchanges and investments in Qualified Opportunity Funds.

HOW ARE PRINCIPAL AND GAINS HANDLED?

1031 Exchanges require investors to swap both the principal (cost basis) and the gains accumulated. A Qualified Opportunity Fund only requires the gains to be transferred. The principal is not required to be rolled into the fund. This has the potential to free up assets and can be beneficial to those who need liquidity.

For example, suppose you sell an eligible asset worth $1 million with a $200,000 cost basis.  In this case, a 1031 exchange requires you to transfer the $1 million sale proceeds into a like-kind property to avoid all taxable gains in a 1031 exchange (you can exchange less, but you will have to pay capital gain taxes on the portion you withdraw).  However, you are only required to move the $800,000 gain into a Qualified Opportunity Fund to avoid a taxable gain.  The $200,000 cost basis can be withdrawn tax-free. 

WHAT ARE THE ELIGIBLE INVESTMENTS FOR EACH STRATEGY?

Sellers can swap into any qualifying investment property in a 1031 Exchange, meaning the replacement property does not have to be from the same asset class, adding diversity to your investments. Once again, this excludes personal property for the same reason as stated with eligible assets. In the case of QOF, individuals are investing in a Qualified Opportunity Zone or QOZ.

The IRS defines an opportunity zone as an “economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatments.” Generally, individuals invest in a pooled set of commercial real estate funds, housing, infrastructure, and businesses within a QOZ. The primary purpose is to spur economic development and job creation within the distressed community.

WHAT IS THE RULE ON REPLACEMENT PROPERTY?

To complete a 1031 Exchange, real estate investors must follow a specified time frame to purchase the replacement properties. You have 45 days to identify a replacement property after you sell the original investment property. Once identified, you must close on that property within 180 days of the sale. The rule on replacement property for a Qualified Opportunity Zone is different. You do not have to identify the replacement property; however, you must reinvest the capital gain in a QOF within 180 days.

WHAT HAPPENS WITH CAPITAL GAINS TAX?

1031 Exchanges provide tax deferral, not forgiveness. You defer the taxable gain until you sell the replacement property. You can eventually eliminate the capital gain if you continue to perform 1031 Exchanges up to the time you die. Your heirs receive a step-up in the cost basis to the date of your death, eliminating the capital gain tax.

With a Qualified Opportunity Fund, there are a few moving parts. First, you can defer the capital gain tax until you sell the Qualified Opportunity Fund or until December 31, 2026, whichever occurs first.  There is no limit on the number of gains that you can defer in this manner.

Qualified Opportunity Funds also have the potential to reduce capital gains through a step-up in cost basis. If you invest in a Qualified Opportunity Fund before December 31, 2021, and hold until 2026 you can receive a 10% step-up in your original cost basis.

Finally, Qualified Opportunity Funds provide you an opportunity to eliminate any additional capital gains on the new investment.  Specifically, if you hold the Qualified Opportunity Fund for at least ten years, you will not pay any capital gain on the new investment, regardless of the potential profit size.

While both strategies can help reduce your taxes, there are several differences between a 1031 Exchange and a Qualified Opportunity Fund that you should understand before investing in either method. An elite wealth manager who understands the unique needs of real estate investors and what you want to accomplish moving forward can help lead you in the right direction.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

What Types of Charitable Giving Accounts Might Be Best for My Family?

The variety and complexity of charitable giving options can be overwhelming.  A wealth manager with expertise in charitable giving can help guide you to an intelligent philanthropic approach. So put away the checkbook, and let’s review two charitable giving options: Donor-Advised Funds and Charitable Remainder Trusts. 

An increasing number of families and business owners want to support the causes they care about, both while they are alive, and after they pass. For charitable-minded families, several gifting vehicles not only help you better meet your philanthropic goals but can also help you address other important issues –  reducing taxes, increasing cash flow, transferring wealth efficiently, and protecting your assets.  The optimal charitable strategy for you will depend on your values, goals, and objectives.

DONOR-ADVISED FUNDS

A Donor-Advised Fund is a 501c(3) charity organization that receives donations from you, allows you to invest those contributions, and specifies whom you want to grant your gifts. Donor-Advised Fund accounts are easy to use. Most large brokerage firms such as Charles Schwab, Fidelity, and Vanguard have user-friendly client portals, which can come in handy if you donate to several charities.

With a Donor Advised Fund, you receive an immediate tax deduction when you fund the account, and the account can grow tax-free based on the performance of the investments selected. It is typically best to fund the account with appreciated assets you would otherwise pay capital gain taxes on the sale because you eliminate capital gains tax. Tax mitigation is the main reason people chose donor-advised funds as a charitable gifting vehicle.

Some firms that offer donor-advised funds have account size and donation minimums, so you will want to find out what they are before opening your account. Once you fund the account, the invested money remains in the account until you decide which charities make gifts, which could be at any time, even years down the road.

CHARITABLE REMAINDER TRUSTS (CRT)

A Charitable Remainder Trust can generate an income stream for yourself or any person(s) you choose. You can design the income to be for a set period or your lifetime. Once the trust disperses the funds to the named beneficiaries, the trust gifts the remaining assets to charities that you choose. It also provides you an immediate charitable deduction in the year you fund the account.

A Charitable Remainder Trust has several potential benefits.  First, it helps fulfill your charitable gifting goals.  Second, it helps provide income for your living needs or any person(s) you choose.  Third, the trust assets grow tax-deferred.  Additionally, you are eligible for an immediate tax deduction to help offset other taxable income.  Finally, the assets are removed from your estate, potentially helping to reduce estate taxes.

There are two caveats in a Charitable Remainder Trust you should understand.  You have to select the charities when you establish the trust, years before the gift will occur. For this reason, some people will choose their donor-advised fund as the charitable beneficiary of the trust because they can have more control over naming and changing charities that receive the remaining funds.  Also, the trust is irrevocable, meaning that you cannot change your mind once the assets are transferred to the trust.  You give up ownership of the assets in return for the potential income stream.

THERE ARE TWO DIFFERENT KINDS OF CRTs:

Charitable Remainder Annuity Trust (CRAT) and a Charitable Remainder Unitrust (CRUT)

A CRAT will pay a fixed dollar amount to the person you designate for a set number of years, with a maximum of twenty years. For example, you can select the amount at $45,000 annually.  You cannot change the payout amount once set even if the trust assets grow more than the distribution.  You also cannot add future assets to a CRAT once it is established.

A CRUT pays a set percentage of the trust assets each year, instead of a fixed dollar amount in a CRAT. For example, you can choose to pay out 7% of the trust assets annually.  The income stream varies each year based on changes in the trust value as it increases or decreases. The annual payment increases or decreases with the value of the assets in the trust.

WHAT ARE THE BEST ASSETS TO GIFT?

Your best option is to gift appreciated assets (stocks, real estate, private business shares, etc.) that will otherwise incur a capital gain tax upon the sale.  Once you make the gift with the appreciated assets, you eliminate the capital gain tax liability.  The charitable giving vehicle – Donor-advised fund or Charitable Trust – sells the investment in a tax-exempt structure.  Compare this strategy to first selling the asset, paying the tax, and then gifting cash. Ideally, you will never make charitable gifts with cash. 

Affluent families practice intelligent philanthropy using IRS-approved tools to make more impactful charitable gifts while also improving their financial security.  You don’t have to be ultra-rich to benefit from the same strategies.  Make sure your advisor is knowledgeable with philanthropic planning or has access to experts in this field.  

Charitable Trusts and Donor-advised funds can be wise options to help you meet your philanthropic goals.  These charitable giving vehicles can also improve your personal finances significantly with the potential for increased income streams and reduced taxes. 

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Little Known Ways for Business Owners to Reduce Taxes

Business owners have numerous ways to reduce their tax bills for both themselves and their companies.  Some of the methods are more commonly understood; however, many tax strategies are relatively unknown to even the brightest of entrepreneurs. 

Little-known tax strategies are not a secret because they are written in the tax code and approved by the IRS.  Wealth managers, accountants, and tax attorneys should all know about these and other ways for you to avoid paying more than your share of taxes.

BUSINESS OWNERS TAX STRATEGIES: QUALIFIED RETIREMENT PLANS

A qualified retirement plan meets the definition laid out in Section 401(a) of the tax code, allowing both business owners and employees to make pre-tax contributions, which then grow tax-deferred.  There are two basic types of qualified retirement plans: defined contribution and defined benefit plans.

Defined contribution plans, such as 401(k) plans, are more common.  Business owners benefit from tax strategies in two ways from such programs.  First, they can reduce taxable business income through employer contributions.  Second, they can reduce their personal taxable income by deferring part of their salary.

If you are over 50 years old, looking for ways to reduce taxable income and sock away a larger retirement nest egg, then a defined benefit plan may be your answer and can be an ideal solution for many business owners. 

Selling or transferring ownership of your business to new owners or family members can trigger a significant tax event.  One strategy that you can use to reduce a hefty capital gain tax on the sale is to freeze the value of your business. 

After you “lock-in” the business value, you will avoid capital gain taxes on any further increase in value.  Additionally, freezing the value can reduce or eliminate estate, gift, and generation-skipping taxes on any further value increase.  Freezing your business value can be a particularly effective tax mitigation strategy if you plan to transfer business ownership to children and grandchildren.

BUSINESS OWNERS TAX STRATEGIES: HIRE FAMILY MEMBERS

Hiring family members can yield significant tax benefits, particularly for small business owners under a sole proprietorship or single-member LLC.  For example, you can hire your spouse and provide all or most of their compensation in the form of a medical expense reimbursement plan.  This benefit is allowed in section 105 of the IRS tax code.

A section 105 plan allows for the tax-free reimbursement of healthcare and dental insurance premiums, along with out-of-pocket medical, dental, eye care, and other eligible medical expenses. Medical expense reimbursement plans can be significant tax savings for small business owners.

You can also hire your children to assist you in any number of ways. While they are minors, the salary you pay them is free from payroll taxes.  The salary is taxed at their minimal tax rate, and you can help them save the income for college.  

If your children attend college when they are 18 or older, they can claim themselves as dependents and receive tax credits up to $2500 annually.  Since this is a credit instead of a deduction, they can earn close to $40,000 annually free from federal taxes.  Compare that to the amount of taxes you would pay on the same $40,000, and you see how the tax savings of hiring your college-age children can add up.

CAPTIVE INSURANCE COMPANIES

Section 831(b) of the Internal Revenue Code allows business owners to set up their company as an insurance company as a wholly-owned subsidiary.  This captive insurance company ensures the risks of the parent company. 

The parent company funds the insurance operation tax-free.  The parent company also controls the premiums and claims, taking the commercial insurance company’s profit and the claims hassle out of the equation.  The investment income from the captive insurance operation is tax-exempt (not merely tax-deferred).

As a business owner, there are various types of captives for varying business needs. Still, most generally allow for tax-free funding of the insurance operation and tax-exempt income from the insurance operating profit. 

CHARITABLE TRUSTS

You can avoid capital gain taxes on the appreciated value of your business by first gifting the shares to a charitable trust before the sale.  Charitable trusts are powerful for business owners because it avoids capital gain taxes on the sale. 

It is best to use charitable trusts in combination with objectives other than tax reduction.  One example of this type of tax strategy is if you or a beneficiary you name can receive income distributions for life from the trust.  When you gift appreciated assets to a charitable trust, you also receive charitable tax deductions to help offset taxes on other income sources.

The Internal Revenue Code has hundreds of sections, many of which establish legitimate ways for business owners to avoid taxes and reduce the amount you pay to Uncle Sam over a lifetime.  Working with a tax-smart professional who understands your values, goals, and objectives can help guide you to the proper tax reduction strategies for you.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

1031 Exchange: The Basics for Real Estate Investors

If you are a real estate investor and are looking to sell some or all your appreciated real estate assets, one consideration is the tax liability at the disposition of your property. Depending on certain factors, the tax bill generated from the sale of one or all your properties can be a hard pill to swallow. It may even discourage some investors from selling their property to avoid forking over proceeds from their hard-earned assets to Uncle Sam. However, there is a tool that can serve as a solution to this problem, known as the 1031 exchange.

This is a procedure that allows the owner of investment property to sell it and buy like-kind property while deferring capital gains tax. On this page, you’ll find a summary of the key points of the 1031 exchange—rules, concepts, and definitions you should know if you’re thinking of getting started with a section 1031 transaction.

BRIEF HISTORY OF 1031 LIKE-KIND EXCHANGE

The 1031 Like-Kind Exchange was first introduced by Congress in 1921, realizing the importance of encouraging reinvestment in business assets. The 1031 Like-Kind Exchanges gets its name from section 1031 of the IRS tax code. The code provides that you will not recognize a taxable gain on real estate exchange, provided you meet the IRS requirements.

WHAT IS A 1031 LIKE-KIND EXCHANGE?

A 1031 Exchange allows real estate investors to completely defer all federal and state taxes on relinquished property when the investor reinvests their sale proceeds into a “like-kind” property. Often, investors can be confused about what a “like-kind” property is. “Like-kind” means you are selling one piece of investment real estate and buying another piece of investment real estate. You also do not have to remain in the same real estate sector, allowing you to exchange virtually any real estate for any other property, except for personal property, as this specific asset class does not qualify for the exchange.

1031 Like-Kind Exchanges provide tax deferral, not forgiveness. If you eventually sell the replacement property without exchanging the proceeds into yet another ‘like-kind” property, you will realize the gain, and a tax bill is due.

WHAT IS A QUALIFIED INTERMEDIARY?

A Qualified Intermediary, also commonly known as the accommodator or QI, is an entity that facilitates Section 1031 tax-deferred exchanges. The QI enters into a written agreement with the real estate seller to make sure the process of the 1031 Like-Kind Exchange flows smoothly and efficiently.

QIs play a pivotal role in a 1031 exchange.  Some of their responsibilities include preparing the exchange agreement, holding the net sale proceeds from the relinquished property in an escrow account, helping to identify replacement properties, and transferring funds to purchase the replacement properties.  They may also provide in-house legal and tax teams to provide additional support.

WHAT IS A 1031 LIKE-KIND EXCHANGE TIMELINE?

The timeline of a 1031 Like-Kind Exchange begins with the sale of the relinquished property. The qualified intermediary holds the proceeds from the sold property. Within 45 days of the sale date, you must identify the potential replacement properties to exchange the sale proceeds. Finally, you must complete the acquisition of any replacement properties by 180 days from the sale date.

WHAT ARE THE BENEFITS OF A 1031 LIKE-KIND EXCHANGE?

Portfolio Diversification/Consolidation: As a real estate investor, you can exchange one higher valued property for several other properties to own a diverse group of real estate investments. You are not limited to a specific geographical area when doing a 1031 Exchange allowing you to purchase property anywhere within the United States. On the other hand, if you find a great investment opportunity in a larger property, you can exchange multiple properties with lower values into one higher valued property.  

Access to Higher Quality Real Estate: By not paying taxes on the relinquished property, the money you would have paid to the government you can use to trade up for your benefit. It allows you to potentially purchase more expensive or higher-quality real estate that better matches your investing goals and needs.

Potential Tax Forgiveness to Your Heirs: If you own appreciated real estate when you die, your heirs will receive a step-up up in cost basis equal to the fair market value at the time of your death, eliminating a large tax bill.  However, you may want to sell appreciated properties during your life for any number of reasons.  For example, you might believe the price is attractive to sell, or you may want to eliminate the headaches of being a landlord.   In these cases, a 1031 Like-Kind Exchange eliminates several taxes, including federal and state capital gain and depreciation recapture taxes.  For this reason, 1031 Exchanges can be a great strategy to transfer more of your wealth to your heirs instead of paying taxes to the government.

WHAT ARE THE DRAWBACKS OF A 1031 LIKE-KIND EXCHANGE?

Tight Timeline: As discussed, you must follow a strict timeline to complete a 1031 Like-Kind Exchange successfully. Failure to meet any step within its specified time frame can result in the termination of the exchange. A 1031 Like-kind Exchange may not be the best option if you are not prepared to move quickly.  Consider lining up a commercial real estate agent, a qualified intermediary, and an attorney ahead of time to help you meet the timeline.  A wealth manager specializing in the needs of successful real estate investors can help you assemble a knowledgeable and experienced team to help you complete the process successfully.

Liquidity: The assets from the sale of the relinquished property will remain invested in real estate. You will not be able to use proceeds for any other use, whether personal or business-related. To access funds for use other than investment real estate purchases, you will have to realize all or part of the gain and pay all applicable taxes.

Taxable Boot: The term “boot” means any money left over from the sale of your property after you close. Although this is a case-by-case basis, any money leftover from the deal you do not exchange into “like-kind” property can incur a taxable gain.

It’s easy to see why a 1031 Like-Kind Exchange is a valuable tool for successful real estate investors. However, it must be executed correctly and on time. Therefore, it is essential to reach out to a knowledgeable professional to help guide you through the exchange process.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Retirement Planning: Qualified Retirement Plans for Business Owners

qualified retirement plans, defined contribution plans, defined benefit plans, retirement planning, business owners

It’s no secret that business owners constantly search for different ways to reduce their tax obligations legally, especially when it comes to retirement planning. So why is it that so many successful business owners fail to take advantage of the government-sanctioned methods embedded in the tax code? Qualified Retirement Plans provide business owners with a legal way to reduce their annual tax obligations while also saving money to ensure they can fund the lifestyle they desire in retirement.

Although it sounds surprising, the government supports tax avoidance by intentionally creating ways to reduce your tax obligations legally. The government has social goals and offers incentives, written into the tax code, to those who participate in helping to achieve those goals. 

As the population continues to grow and the average lifespan continues to increase, the social goal of people having enough money saved to fund the rest of their lives once they are no longer working is becoming even more critical. Thus, the government uses Qualified Retirement Plans to motivate and incentivize people to save for retirement long before it becomes a concern.

WHAT IS A QUALIFIED RETIREMENT PLAN?

If you are a business owner, you have probably spent most of your adult life dedicated to your business. In some cases, that means saving for retirement took a back seat to the priority of building a successful business. Qualified Retirement Plans provide business owners with a legal way to reduce their annual tax obligations while also saving money to ensure they can fund the lifestyle they desire in retirement.

Qualified Retirement Plans typically allow you to contribute pre-tax dollars to an account intended to fund your retirement, helping you reduce your current taxable income by the contribution amount. The account grows tax-deferred and isn’t taxed until you withdraw funds from it when you more than likely move into a lower tax bracket during retirement years. For your retirement planning needs, reducing your current taxable income by the contribution amount while you are in a higher tax bracket and transferring it to a time later in your life when you may be in a lower tax bracket can be an attractive strategy for successful business owners.

When it comes to retirement planning for business owners, there are two different types of Qualified Retirement Plans: Defined Contribution Plans and Defined Benefit Plans.

DEFINED CONTRIBUTION PLANS

Most business owners preparing for retirement planning are familiar with Defined Contribution Plans—retirement saving vehicles that allow you to contribute a specified percentage or fixed amount of every paycheck to the plan. With this type of retirement plan, there are limits on how much the participant can contribute each year. Though there are limits, a Defined Contribution is more flexible of the Qualified Retirement Plan because you are not required to contribute every year.

For that reason, Defined Contribution Plans are generally more favorable to younger business owners who have a longer time horizon until retirement or for business owners with unpredictable cash flows. The retirement benefit is determined by the contributions made to the account and its investment performance over time; therefore, the expected benefit at retirement is uncertain.

Types of Defined Contribution Plans include 401(k) Plans, Profit Sharing Plans, and SEP-IRA Plans.

DEFINED BENEFIT PLANS

A Defined Benefit Plan can add significant value in maximizing personal wealth for the right business owner’s retirement planning. Defined Benefit Plans are retirement-saving vehicles that allow you to target a specified benefit amount to receive at retirement. The contribution amount is calculated and adjusted annually to ensure you reach the specified benefit amount upon retirement. There are no set maximum annual contribution limits. Therefore, a Defined Benefit Plan allows for significantly higher annual contributions—making the potential tax benefits for business owners considerably more significant than those of a Defined Contribution Plan. With that said, contributions to a Defined Benefit Plan are not discretionary.  You are required to make the calculated annual contributions to fund the plan adequately.

For those reasons, Defined Benefit Plans could be most beneficial to successful business owners nearing retirement and generating substantial cash flow consistently —making it an excellent option if you want or need to build up sufficient retirement assets quickly. Additionally, the contributions are tax-deductible, making Defined Contribution Plans an excellent tax reduction strategy during the contribution years.

Qualified Retirement Plans are written into the tax code, by the government, as a legal way to reduce your tax obligations to incentivize people to save for retirement.

Have you started saving for retirement?

If you’re a business owner and answered no, the benefits of setting up a Qualified Retirement Plan alone give you a great reason to start.

If you’re a business owner and answered yes, are you sure the type of retirement plan you have in place is the most effective solution for maximizing your wealth?

Whether you’re just starting or revising a Qualified Retirement Plan, many factors come into play when vetting out which type could be most effective for you and your business. Factors include your age, business cash flow, number of employees, entity structure, compensation, and retirement expectations. While most business owners could benefit from having a Qualified Retirement Plan in place, an ideal plan will help you more than others. Elite wealth managers that specialize in understanding the needs of business owners can help you navigate the complex landscape of Qualified Retirement Plans.

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

Does a Roth IRA Conversion Make Sense for Me?

While the taxman may appear to be heartless, he does offer some flexibility when it comes to taxing retirement savings:  You can pay me now, or pay me later when deciding if a Roth IRA Conversion strategy is likely to provide you, your family, and your heirs’ tax-related benefits down the road. 

WHAT IS A ROTH IRA CONVERSION?

Let’s start with some background. 

Traditional IRAs, subject to income limitations, are generally funded with pre-tax earnings.  Potential growth is tax-deferred, and future withdrawals, such as those used to support your living needs in retirement years, are typically taxed as ordinary income.  When you reach age 72, rules call for annual Required Minimum Distributions (RMDs) from your traditional IRAs, adding to your taxable income even if you do not need to withdraw the money for living needs.

Roth IRAs, on the other hand, are funded with after-tax money.  Potential growth is tax-free, subject to certain conditions, and future withdrawals are also tax-free.  Roth IRAs have no RMDs requirements.  Unlike Traditional IRAs, you never have to withdraw money from Roth IRAs unless you want or need the money.

A strategy many people are contemplating is to convert Traditional IRAs to Roth IRAs.  You can convert all or any portion of your Traditional IRAs.  The process itself is relatively straightforward – you transfer money or securities from a traditional IRA account to a Roth IRA account. 

The value converted is considered a taxable distribution and will increase your tax liability for the current year.  The potential benefit is to reduce taxes later in your life by reducing or eliminating your RMDs when tax rates may be higher.    Your heirs also can benefit.  They will inherit a Roth IRA tax-free; no taxes will be due when they withdraw the money from a Roth IRA.  

So, you can see that it is a case of pay me now or pay me later.  The question is – Should I do a Roth Conversion now, pay potentially lower taxes up-front, and then enjoy tax-free withdrawals down the road for myself and my heirs? 

As is often the case in life, the answer is, it depends.  Each family’s circumstances are different, and there is no one size fits all solution. 

WHAT ARE THE CONSIDERATIONS FOR IMPLEMENTING A ROTH IRA CONVERSION STRATEGY?

  • Future Tax Rates:  The reason often cited for implementing a Roth Conversion strategy is the possibility of tax rate hikes in the coming years – it’s the difference between paying a known tax rate now versus paying unknown rates in future years.  While no one can predict future tax rates, there are a few factors to consider. The last time the Federal Debt was as high as a percent of GDP as it currently is, was at the end of World War II.  Following that period, the top individual tax rate rose above 90% until 1964 and remained above 70% until 1970.  Today we live in a relatively low tax environment with a maximum individual tax rate of 37%.  That could change with current tax proposals.  Higher future tax rates may make Roth Conversion strategies appealing. 
  • Reduce or Eliminate Future RMDs: Converting Traditional IRAs to Roth IRAs reduces or eliminates your future RMDs.  If you have sufficient income sources or assets to fund your lifestyle, then RMDs are unnecessary for your living needs.  Since RMDs increase your taxable income, reducing them can reduce the taxes you pay on other sources of income throughout your retirement years. As mentioned earlier, RMDs start at age 72 and continue for the rest of your life.  Therefore, reducing taxable income from RMDs can be significant tax savings for many years after age 72. An elite wealth manager can help you develop a Lifetime Cash Flow Plan to help you determine if RMDs are necessary for your situation.
  • Tax-Free Growth: After you convert funds to a Roth IRA, the assets can potentially grow tax-free.  The converted assets and growth can be withdrawn tax-free for your needs later in life.  In many cases, much of the Roth IRA value will pass to your heirs.  They will benefit from a tax-free inheritance. 
  • A Roth Conversion Could Push you into a Higher Tax Bracket: To avoid surprises with your tax liability in the year you perform a Roth Conversion, you should understand how much capacity you have in your current tax bracket and your comfort level for paying a higher rate on income above that threshold.  One strategy is to execute Roth Conversions over several years to manage the up-front tax burden.    
  • Medicare surcharge: Medicare Part B premiums could increase if a Roth Conversion increases your Modified Adjusted Gross Income (MAGI) above certain levels.  Your Medicare premium is based upon your tax filing from two years ago, so a Roth Conversion this year could increase your Medicare premiums two years down the road.  Conversions could also impact your Medicare Part D (prescription drug coverage) premiums, so be sure to work with a professional who understands these nuances.  Any increase in Medicare premiums from Roth Conversions is most likely temporary.  However, by reducing RMDs in future years, your MAGI may be lower later in life, reducing Medicare premiums at that time.

HOW DO I KNOW IF A ROTH IRA CONVERSION IS RIGHT FOR ME?

There are many moving parts to forecasting a family’s tax obligation with or without Roth Conversions.  Some wealth managers use tax planning software that includes various inputs for your family’s situation to run what-if analysis on different Roth Conversion scenarios.  Lifetime Cash Flow Planning helps you forecast potential tax obligations in future years and compare them to performing Roth.  Armed with this data, families can make informed decisions about whether Roth Conversions may benefit them. 

A WORD ABOUT HEIRS

If one of your financial objectives is to leave a legacy to your children or grandchildren, some planning now might make their inheritance more impactful.  When your adult child inherits a Traditional IRA or Roth IRA, they must withdraw all assets from the account within ten years.  Distributions from inherited Roth IRAs are tax-free; however, distributions from inherited Traditional IRAs are taxable.  Furthermore, suppose your child inherits a Traditional IRA at a time they are already in a high tax bracket. In that case, the additional taxable income from mandatory IRA distributions will be taxed at high rates or may push them into even higher tax brackets.  Your heirs may appreciate proactive planning in passing assets in Roth IRAs rather than Traditional IRAs! 

There are many moving parts when analyzing if a Roth Conversion is proper for you.  Be sure to work with a professional who can help you forecast tax implications under various scenarios.  A Roth Conversion strategy could be of great benefit for some people, while for others, no action may be the best course of action. 

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

1031 Exchange: Biden Pushes to End Real Estate Investment Tax Break

Many real estate investors are accustomed to buying and selling properties without having to pay taxes.  More specifically, a provision in the current tax law allows investors to essentially exchange their property for another of “like-kind” and defer settling the tax bill, known as the 1031 like-kind exchange. President Biden’s new tax proposal seeks to abolish the right to this tax deferral on property investment gains above a specified amount.

THE PAST 100 YEARS OF THE 1031 LIKE-KIND EXCHANGE

For the past 100 years, the IRS has allowed real estate owners and investors to exchange investment property for other investment property and defer the tax on any unrealized gains. The government collects taxes only when a property is sold and not traded into a “like-kind” property.

This tax provision exists under Section 1031 of the U.S. Tax Code and is generally referred to as a 1031 like-kind exchange or 1031 exchange.  In addition to deferring taxes on the gain in real estate value, a 1031 exchange also defers tax that would be due on the recapture of depreciation when you sell a property.  

1031 exchanges provide an economic stimulus to the real estate industry by incentivizing property sellers to reinvest proceeds in other properties.  Professionals that service real estate the real estate industry also benefit commercial lenders, real estate agents, insurers, attorneys, contractors, and many other groups.   

BIDEN’S PROPOSED TAX LAW CHANGE TO ELIMINATE THE 1031 EXCHANGE

This past April, the Biden administration announced another part of its infrastructure and economic plan. Called the American Families Plan, the proposal provides $1.8 trillion of new spending in several areas.  The plan aims to raise taxes on “wealthy” households, raising an estimated $1.5 trillion over the next decade to help pay for the increased spending. In addition to raising the income tax rate on the top 1% of earners and raising the capital gains tax rate on households making over $1 million, the proposal targets people who own and could benefit from a 1031 exchange. 

The proposal would eliminate a 1031 exchange on properties priced above $500,000. Currently, it’s not clear if this limit applies per year or per property.  The consensus seems to be that it will apply per transaction.  

Some politicians portray 1031 exchanges as a tax loophole for the wealthy. While the proposed changes will impact large investors, they could also touch smaller landlords who have built equity over many years, perhaps even decades. Many of these folks are not the wealthy the politicians are aiming to hit with increased taxes, yet they will be caught in the crosshairs of the proposed change.

Further, large commercial real estate investors often use the additional capital saved by deferring taxes to invest in and upgrade abandoned or underused real estate (shopping malls or warehouses).  The proposed tax law change could remove incentives for such reinvestment and materially impact the communities and people the American Families Plan and infrastructure plans intend to help.  In addition, fewer deals will mean less spillover work/income for many direct and indirect real estate-related industries.

WILL BIDEN’S PROPOSED TAX LAW PASS?

The possible good news?  The 1031 exchange has been attacked at almost every new tax proposal over the past 30 years and has survived. Since the Democrats hold only the thinnest of margins in the Senate, they’ll likely need every Democratic senator to vote in favor of the tax proposal. 

Limiting the 1031 exchange could be a tough sell for senators from specific states, perhaps requiring concessions to get the legislation through. This proposal would contribute about $40 billion toward the $1.5 trillion in projected revenue. That’s less than 3%.  Accordingly, the proposed limit on 1031 exchanges could be an easy one to pull as many lawmakers may not see it as worth the massive push-back they’ll surely face from the real estate industry. 

LOOKING AHEAD

The 1031 exchange has managed to survive for the past 100 years, in large part due to its substantial benefits.  Any successful efforts to limit the ability to use this critical provision in the tax law could have far-reaching and unintended consequences on the economy and the many people who currently benefit from it. 

DISCLOSURE & ACKNOWLEDGEMENT

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.

President Biden’s Tax Plan: How Will it Affect Family Wealth?

The tax increases proposed in President Biden’s tax plan are aimed squarely at business owners and family wealth.

The good news: You may still have time to prepare for any tax law changes that result from the proposal—still must wind its way through the legislative process and be signed into law by the President.  That means Congress can make any number of changes to the proposal.

While it is possible any new tax law would be retroactive to January 1, 2021, most experts feel that it is not likely.  That means that you may still be able to implement tax-smart strategies this year. 

BIDEN’S TAX PLAN IS COMING AFTER FAMILY WEALTH FROM MULTIPLE ANGLES

President Biden’s tax plan has made it clear that he wants to raise tax revenue; he also has made it clear that he wants the source of the additional taxes to come from businesses and the wealthy.

With Democrats holding a narrow majority in the U.S. House of Representatives and Senate, there is no way to predict how the proposed plan will compare with tax law changes that President Biden may eventually sign into law.  But, Biden’s tax plan, as currently proposed, seeks to increase taxes on family wealth from several sources:

  • Increased marginal income tax rates
  • Increased capital gains taxes
  • Increased estate taxes after death

If you are a business owner, you will want to explore proposed changes for businesses.  While no one has a crystal ball, the current administration will likely implement some tax law changes.  Total U.S. Public Debt soared over 19% in 2020 as the government responded to the economic crisis created by the COVID-19 lockdown.  At the end of 2020, federal debt totaled over $27 trillion.  There is mounting pressure to begin to deal with the increasing deficit somehow, and President Biden’s American Families Plan aims to do just that.

BAD NEWS FOR FAMILY WEALTH TAXES

Your family’s wealth could be affected by several critical provisions of Biden’s tax plan proposal.  Some of the most impacting issues include:

  • Increase to the top marginal income tax rate.  The proposal includes raising top rates from 37 percent to 39.6 percent.  That would apply to income over $452,700 for those filing as single and head of household and $509,300 for joint filers.
  • Increase to Capital Gains and Dividend tax rates.  The plan calls for increased capital gain and dividend taxes for families with a taxable income above $1 million per year.  Long-term capital gains and dividends would be taxed at the top ordinary income tax rate of 39.6%.  Adding in the 3.8% Net Interest Income Tax (NIIT), the effective tax rate would be 43.4%.  Currently, the maximum tax rate for long-term capital gains and dividends is just 20%, or 23.8%, when including NIIT.
  • Increased taxes after Taxpayer(s) death.  These proposed changes could carry significant tax implications for your heirs.  The plan would tax unrealized gains greater than $1 million upon your death, even if your heirs have not sold the asset.  The current tax code allows for a step-up in the cost basis of unrealized gains to the value on the date of death, effectively eliminating the capital gain tax liability for your heirs.  Additionally, an estate tax can be due on the same asset if your estate size exceeds specific levels.  According to the Tax Foundation, the combination of capital gain, NIIT and estate taxes can add up to a total tax rate of 61% on unrealized gains over $1 million.  There is likely to be additional state taxes depending on your state of residence.  All of these taxes add up to only a small percentage getting passed to your heirs.  Suppose you owned a private business or investment real estate that has appreciated over many years. Your lifelong asset accumulation would largely be swept up in taxes when you die.

Which provisions in President Biden’s tax plan may potentially affect your family? It all depends on your unique situation.  An experienced wealth manager knowledgeable in advanced tax planning for family wealth, business owners or real estate investors can help guide you in a proactive tax mitigation plan.

ANALYZE YOUR FAMILY’S TAX SITUATION

Each family could potentially be affected in different ways by any new tax law.  Here are some ways to think about the potential impact.  Of course, families may fit more than one of the categories below.

  1. High Earning Families. If you earn significantly more than $500,000, you will likely pay more in taxes under the proposed plan.  Your goal could be to seek out strategies that will lower your taxable income.  For example, you might investigate income deferral plans with your employer.
  2. Families with Large Unrealized Capital Gains.   Suppose you have taxable income greater than $1 million and are sitting on significant unrealized long-term capital gains in assets. In that case, you will likely pay a much higher rate when selling the asset.  For example, suppose you are a long-term employee that accumulated many shares of your employer at a low cost-basis. In that case, you will pay significantly more in capital gains taxes under the proposed plan.  Owners of private businesses and appreciated real estate fall into a similar predicament.  Your priority could be to look for strategies that would help reduce, defer or eliminate the capital gain tax liability.  For example, you might investigate tax-loss harvesting strategies to minimize total capital gains for the tax year.  You can also consider advanced charitable trust strategies that can eliminate the capital gain tax.
  3. Families Preparing for the Transfer of Assets.  Suppose you have family assets that have appreciated significantly over the years. In that case, you may be sitting on significant unrealized capital gains that upon your death would be treated differently under the proposed tax plan.  Under the proposed law, capital gains greater than $1 million would incur a tax rate as high as 43.8% in addition to potential estate and state taxes when you die.  In these situations, your goal would be to search for advanced tax planning strategies designed to mitigate the tax liability for your heirs and wealth transfer strategies designed to reduce or eliminate your wealth transfer tax burden. One positive note here – lawmakers intend to build in exclusions for family-owned businesses and farms if the heirs continue to run the business. 

GETTING PROFESSIONAL HELP

Proposals in President Biden’s tax plan are aimed squarely at increased taxes on family wealth, successful business owners and real estate investors.  Your family’s situation is unique. Any number of the proposed tax increases can affect your family’s wealth depending on your unique situation.  Contact your team of advisors to assess your position relative to the proposed changes, identify areas of concern, and develop a plan to address those concerns.  An elite wealth manager can help you create a custom advanced wealth plan to minimize your tax liability.  If you don’t take proactive action and plan for potential changes, you may be caught flat-footed and miss opportunities to minimize taxes.

DISCLOSURE & ACKNOWLEDGEMENT:

The information included in this material is for informational purposes only and should not be relied upon for any financial or legal purposes. Arlington Capital Management Inc, dba Arlington Wealth Management (AWM) is an investment adviser registered with the U.S. Securities and Exchange Commission.  Our registration with the SEC or with any state securities authority does not imply a certain level of skill or training, nor are we selling you any product.  Rather, we are seeking to provide you with advisory services.   Please consult with your own tax and legal advisers before investing. AWM cannot and does not guarantee the performance of any investment.  Past performance is no guarantee of future results.