Maximizing Profits: Strategies for a Tax-Efficient Sale of Business Interests, Real Estate, and Other Highly Appreciated Assets
The tax burden of selling highly appreciated assets can be overwhelming. However, there are numerous tax-advantaged strategies available for selling assets like closely held businesses and real estate. The best outcomes often arise when clients plan ahead.
Many business owners overlook the tax consequences when selling their business because they are focused on other complex aspects of the transition. Exploring tax-advantaged sale options may seem like a distraction, but it is crucial to optimize profits especially when they will likely be in a higher tax bracket the year of the sale.
Closely held businesses in the U.S. are often structured as S-Corporations, and most S-Corporation sales are structured as asset sales rather than stock sales because new owners do not want the lingering liability and want a step up in the basis of depreciable assets. This can result in some of the proceeds being subject to ordinary income taxes.
Real estate owners often fear paying capital gains tax upon sale. They may hold onto the property until death to benefit from the step-up in basis, limiting their ability to diversify and use the proceeds during their lifetime.
Fortunately, there are many tax-efficient tools to help individuals retain more of their hard-earned proceeds from the sale of a business, real estate, or other highly appreciated assets. These tools include both charitable and non-charitable options, as well as tax-deductible investments. The entity structure can impact which tools are viable.
Let’s delve into some of these planning tools:
Charitable Tax Planning Tools
A Donor Advised Fund (DAF) is a very effective giving tool to maximize tax deductions and create a family legacy. A DAF is created within a 501c3 organization which allows the donor to create their own charitable investment account and make donations to qualified charitable organizations (501c3) over time. A DAF also allows the family to create a legacy and include children and grandchildren in philanthropic endeavors for generations. A DAF can teach family values and educate future generations by having them research and deliver proposals about organizations they would like to recommend for grants. Some DAFs can accept all types of Stock (including S-Corp), and it can be the remainder charitable beneficiary of other tools like a Charitable Remainder Trust (CRT), Pooled Income Fund (PIF), Charitable Lead Trust (CLT), and both CLTs mentioned below.
Private Foundations (PF) can be limiting due to onerous rules and regulations, 5% mandatory distributions, and the fact that the donor can only deduct the basis of appreciated asset gifts versus the fair market value. A Donor Advised Fund can be a great alternative to a PF, and it can provide anonymity. For assets over $5 million, a Supporting Organization (SO) can be created to look like a private foundation by supporting a class of nonprofits and having board members from that class of nonprofits. The SO can potentially provide a higher tax deduction and more flexibility.
Tax savings plus a deduction can make a Charitable Remainder Trust (CRT) or a Pooled Income Fund (PIF) very attractive, even if the client is not very charitable. The client can sell the asset tax-free, keep those tax dollars working for them by providing lifetime income from the whole asset, and receive a tax deduction today for their future remainder interest gift to charity. A CRT does best in a high-interest-rate environment, and a PIF does better in a low-interest-rate environment. The PIF can allow for up to 10 income beneficiaries, but neither tool can accept S-Corp stock. PIFs have not received much attention in the last 20-30 years, but if a new “baby” PIF is created, it can provide better tax deductions than an existing PIF. The newly formed PIF uses the last three years of Applicable Federal Rates (AFR)to calculate the deduction, while existing PIFs usually provide a lower deduction because it is calculated by the last three years of performance.
If the sale has already occurred, a Charitable Lead Trust (CLT) can be used in the same tax year. There are two types of CLTs: Grantor (G-CLT) and Non-Grantor (NG-CLT). Both offer income to charity (and/or a Donor Advised Fund), and allow the remainder to return back to the donor or the donor’s family. A G-CLT provides an income tax deduction, while an NG-CLT is used to solve estate taxes.
Non-Charitable Planning Tools
The 1202 Qualified Small Business Stock (QSBS) is an underutilized vehicle that offers a $10,000,000 tax exclusion or ten times basis for C-Corporations that have been in business for more than 5 years and fit other specifications. CPAs should know if a C-Corporation can qualify, and there are groups that can be found on the internet that can deem qualification. There are potential opportunities to 1045 exchange into other QSBS businesses and use gifting to children.
Employee Stock Ownership Plans (ESOP) can be an excellent strategy for tax-advantaged business sales and enhancing corporate culture. The benefits can be significant and differ if the corporation is a C or an S. ESOPs can be costly to set up and require a lot of yearly maintenance. The benefits can easily outweigh the costs for a large company concerned with tax savings, corporate culture, and employee retention.
Tax Advantaged Investment Options
A 1031 Exchange is a great way for real estate investors to “kick the tax can down the road” and wait for the step up in basis at death by investing in other properties. If they do not want to continue to manage the properties, they can consider investing in a 1031 Delaware Statutory Trust (DST) or an Umbrella Partnership Real Estate Investment Trust (UPREIT). An UPREIT starts as a DST and then rolls into a REIT, providing potentially more investment flexibility.
Oil and Gas investments can also offer significant tax deductions, but the well's output is speculative. Also, Charitable Trusts (CRT, G-CLT, and NG-CLT) allow the donor to be the Trustee and choose the investments inside these vehicles. Some Pooled Income Funds also let the donor choose investment options inside the fund.
Conclusion
There are numerous tax-advantaged opportunities for selling business interests, real estate, and other highly appreciated assets. Optimal results are achieved with ample pre-sale planning. There are other options like gifting to children or changing corporate structure which require planning many years ahead of the exit. Therefore, it is never too early to start planning!
It is also essential to recognize that a comprehensive, well-thought-out strategy will require a team of advisors to ensure that the clients’ financial, tax, retirement, next act, estate, and family plans are all considered when analyzing strategies.
If your clients are selling a business, it is never too early to start the conversation. As mentioned above, the entity type makes a difference as to what strategies can be utilized. You can find a tax advantage business sales tools matrix available for download at www.Tax-Estate.com.
By planning ahead, you can utilize strategic advantages that allow more earnings on exiting and, in turn, more impact on the people, companies, and causes you care about.
For more information, please contact me at [email protected] I am more than willing to address questions and concerns.
Please note the information provided is not intended as legal or tax advice. For such advice, please consult an attorney or financial or tax advisor.
About the Author
Tiffany T. House CAP®, CEPA, FCEP
Tiffany House is a Chartered Advisor in Philanthropy (CAP®), Certified Exit Planning Advisor (CEPA), President and CEO of the Gift Planning Institute and Exit Preparation, LLC Tax & Estate Strategy. She is passionate about inspiring donors to accomplish more through giving tax-advantaged assets and creating a legacy that allows for win-win outcomes. Her experience of being a financial advisor and helping wealthy clients create a master game plan that incorporates their ethical and financial legacy gives her a unique approach to estate and gift planning.
The opinions expressed in this article are solely those of the author and do not reflect the views or endorsements of the American Heart Association (AHA). The AHA does not endorse or assume responsibility for any information or opinions presented in this article.
