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Seven Tax Planning Strategies for Appreciated Assets

With the sustained rise of asset valuations in recent years, managing one’s tax liability on appreciated assets is more important than ever. Here are seven smart tax planning strategies to consider with your clients. By Daniel F. Rahill, CPA, JD, LL.M., CGMA | Digital Exclusive - 2022

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Despite the 2020 pandemic crash and the recent selloff, we have seen a remarkable climb in asset valuations over the past five years. Since December 2016, the S&P 500 is up 115 percent, home values have risen 53 percent, and even collectibles have gone up in value, with contemporary art rocketing up 45 percent. Owning an appreciating asset is certainly desirable, but it comes with a potential cost: a significant tax liability on gains when the asset is sold. Here are seven tax planning strategies CPAs should consider with their clients.

Buy and Hold

Perhaps the simplest financial strategy is for investors to hold an appreciated asset until death. When appreciated property transfers to an heir at death, its cost basis is adjusted to fair market value at that time. Should the heir decide to immediately sell that asset, there would be no capital gains tax associated with the sale.

Capital Gains Harvesting

For investors that anticipate moving into higher tax brackets, tax gain harvesting is a viable option. This involves selling an appreciated asset for a gain and resetting its cost basis by repurchasing the asset, allowing the investor to realize long-term capital gains with little or in some cases no tax expense. Should the investor later move into a higher tax bracket and elect to sell the asset again after appreciation, the capital gain would be lower because of the effective step-up in basis resulting from selling and repurchasing the asset while in a lower tax bracket.

Single individuals with 2022 taxable income of $41,676 and married couples with 2022 taxable income of less than $83,351 are not subject to long-term capital gains tax. Single individuals with taxable income between $41,676 and $459,750 fall into the 15 percent long-term capital gains tax bracket, as do married couples with incomes between $83,351 and $517,200. Investors looking to step-up their tax basis should aim to realize just enough long-term capital gains to stay within the lower tax brackets.

As a reminder, capital gains harvesting applies only to long-term capital gains; short-term gains on assets held one year or less are taxed as ordinary income. Also, the wash-sale rule does not apply to long-term capital gains; it only applies to suspend a tax loss if an investment is sold and then repurchased within 30 days.

Home Sale Exclusion

When a taxpayer sells or exchanges the property he or she has used as a principal residence for two years or more, that taxpayer may exclude up to $250,000 ($500,000 for certain married couples filing jointly) of capital gains during the five-year period ending on the date of the sale or exchange. This makes home sales a great candidate for capital gains harvesting and avoiding a taxable gain on sale.

Grantor Trusts

In 2022, the annual gift tax exclusion is $16,000 for an individual and $32,000 for a married couple that “splits” their gifts. These gifts may be made directly to individuals or to trusts established for the benefit of another. In 2022, the lifetime gift tax exclusion—or the tax-free amount you can give away above the annual gift tax exclusion—is $12.06 million for individuals and $24.12 million for married couples.

Unlike property inherited at death, the beneficiary of your gift assumes your carry-over cost basis in the assets. They do not receive a step-up in basis at the time the gift is made, and therefore should the recipient later sell the asset, the excess of fair market value over the donor’s basis in the gift will be subject to capital gains taxation.

However, through the use of a grantor gift trust, the carry-over basis issue can be solved and the basis step-up can be achieved by providing the donor the power to swap out assets before death. This right of substitution before death gives the donor the ability to take the appreciated assets held in the trust in exchange for an equal amount of cash or other non-appreciated assets. The grantor trust status allows the donor to exchange assets with the gift trust without income tax consequences, and by holding the appreciated asset in the grantor’s name at death, the asset is included in the grantor’s taxable estate and receives the step-up in basis.

Charitable Gift Trusts

Strategic gifting of low-basis assets to charity provides the donor with a fair market value tax deduction at the time of the contribution, thus eliminating the potential for a large capital gains tax. There are several ways a donor can structure a charitable gift to maximize the benefits for themselves, the charity, and their heirs, including irrevocable charitable trusts, charitable remainder trusts (CRT), and charitable lead trusts (CLT).

A CRT allows the grantor to transform highly appreciated assets into an income stream until the grantor’s death or a set date, upon which the remaining assets will go to the qualified charitable organization selected by the grantor. The grantor receives a current tax deduction based on the present value of what will ultimately go to the charity.

A CLT works as the reverse of a CRT, paying an income stream to a qualified charitable organization selected by the grantor for a set period of time, and when that term is up passing the remaining trust assets to the grantor’s heirs. The grantor receives a current tax deduction for the present value of the income stream donated to charity and can minimize the gift tax potential of the gift to their heirs.

Donor-Advised Funds and Private Foundations

A donor-advised fund is a public charity program that allows an individual to make fair market value contributions to the fund, thus avoiding capital gains taxes, and then make recommendations for distributing the funds to qualified nonprofit organizations. A donor-advised fund is a good gifting vehicle if the donor wants simplicity in grant-making, is comfortable serving in only an advisory role, wants higher charitable deduction income limitations, and wishes to support multiple charities.

A private foundation, on the other hand, is a tax-exempt organization usually formed by an individual or family, allowing for more control over assets than a donor-advised fund. Asset contributions are limited to 20 percent of a donor’s adjusted gross income, and up to 30 percent for cash. The fair market value of appreciated assets is a current tax deduction, again avoiding the capital gains tax.

Intra-family Loans and Promissory Notes

And finally, consider intra-family loans in times of high inflation and appreciating assets. Although expected to rise, interest rates are still historically low, and intra-family loans are a simple strategy that can allow more assets to grow for future generations.

Consider this example: A parent loans their child $1 million on April 15, 2022, interest-only for 12 years at an applicable federal rate (AFR) of 2.25 percent (the long-term AFR for April 2022). The child invests in appreciating assets, producing a 10 percent after-tax return. At the end of year 12, the child’s investment has grown to $3,138,428, and the amount due on the loan is $1,306,050. The remaining $1,832,378 is a tax-free transfer of wealth to the next generation, taking advantage of the appreciation in asset value over the period of the loan.

These effective tax planning strategies can help your clients reduce their tax burdens and strengthen their financial positions and that of their heirs—and can help you prove your value as a trusted, strategic advisor.

Illinois CPA Society member Daniel F. Rahill, CPA, JD, LL.M., CGMA, is a managing director at Wintrust Wealth Management. He is also a former chair of the Illinois CPA Society Board of Directors and a current board member of the American Academy of Attorney-CPAs.

Please note, the information provided here was accurate at the time of creation, and is intended to be informative and educational, not to be mistaken as legal, accounting, or tax advice. The description and examples provided are for illustrative purposes only and should not be used as the sole example.


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