Imagine you want to leave your appreciating asset or business to your beneficiary and you have five or more years until you step out of the ring.  What if your business could create a tax free retirement fund for you and your spouse, and at the same time increase your business’s EBITDA?  This is one of Excel Empire’s Founders favorite tool in the tool box for buying out a partner or leaving your business to the kids or favorite employees.

How to Secure a Lifetime Income, Save Taxes, and Benefit a Charity

What does a CRT do?

How does a CRT work

A current income tax deduction may be obtained by creating a qualified living lead trust for a term of years. Property is transferred to the trust and a selected income amount is paid to charity for the chosen number of years. After all income payments have been made, trust principal plus any accumulation is returned to the original owner.  This strategy works great for Restricted Stock Units or Appreciated Stock.

Income Tax Charitable Deduction 

When this grantor lead trust is funded, there is an income tax charitable deduction for the current value of the income which will be distributed to charity. This deduction is taken in the year of the transfer to the lead trust. Under current tax laws, the trust donor receives a current deduction even though he or she will receive the property back again after the term of years. However, the donor must report all trust income, even the portion given to charity, as taxable income on his or her income tax return. Since this income must be reported, many grantor lead trusts are funded with tax-free municipal bonds. If the income distributed to charity is from the tax-free bonds, reporting it on the donor’s tax return generally does not affect his or her taxes during the term of years. Alternatively, some grantor lead trusts are funded with appreciated stock. In this case, there may be some recognition of capital gain during the term of the trust. 

High Income Year

 Living lead trusts with property eventually returned to the original owners are especially attractive for persons who have a large current income and anticipate lower income in future years. A regular charitable giving pattern can be maintained while gaining maximum benefit from the charitable deduction during the high income year.

Property Transfer Back to the Donor

A qualifying grantor lead trust with the donor as remainder beneficiary is an excellent method for giving to charity without permanently releasing title to the property transferred to the trust. A donor gives up only the right to income for the selected number of years. After the term of years, all trust principal and accumulated income is returned to the donor. A living lead trust combines a current deduction with gifts to favorite charities and still allows the donor to retain his or her property.

This is one of the most amazing strategies that nobody has heard about.  Imagine the IRS giving you the opportunity to use your tax money to invest for the next thirty years!

Flexible-

For some, this will be the best value of the TDCO strategy. Instead of having to replace a property with a like-kind property, one can take the proceeds and invest it how they desire. They have two options: business or investing in a financial vehicle of choice (mutual funds, CD’s, stocks, annuities, etc.)

For example, let’s say that an investor has multiple properties. They have leveraged debt on every property to increase their portfolio. One of their properties happens to be a highly appreciated property. They sell it and use the resources to pay off debts on other investment properties. That would be considered business use. Now, they have less debt.

The investor could choose to buy a much lower priced property in another market and put the balance of the funds in a financial investment vehicle of choice. They can start any kind of business venture that they would like. They have options!!

Exit Strategy

In many cases, owners of investment properties no longer want to own those properties and deal with the challenges that come with tenants, laws, and so on. As we like to say, they don’t want to deal with the “tenants, trash, and toilets”. They’d like to “retire” from being a landlord. With a 1031 Exchange, you stay a landlord!

With the TDCO, the owner can sell their investment property and invest it into other financial vehicles that can create passive income from the growth. They might also choose to invest in other passive income business opportunities. They have options!

No Pressing Time Tables

Let’s face it, now is a great time to sale but a difficult time to find an exchange property.  What if you could sell now and wait for the market to become more favorable to you the buyer? With a 1031 Exchange, the investor needs to identify up to 3 potential replacement properties within 45 days and close one or more of the identified properties within 180 days. This works great if the market is great for buyers. But what if the market is not doing well and there are not enough good properties to choose from? What if there are multiple offers on every property? There is always that big “what if”.

I’ve met too many people that basically said, “had I known I was going to end up with this property, I would not have sold the last one.” Tragedy. A common issue with these requirements is loss of negotiating power. When an investor is required to meet these deadlines, they may have to offer more on an identified property because they may be competing with other buyers to purchase it.

With the TDCO strategy, there are no replacement time requirements. The investor can take the time needed to find the right property, the right fit, the right market, and without time pressures. If it takes 1, 2, 3, or more years, that is okay!

Rescue a Failing 1031

Many 1031 Exchanges fail due to the above mentioned 45/180-day restrictions not being met, for many reasons. When that happens, Uncle Sam will be asking for that tax money the following April. Yes, another tragedy!

With the TDCO strategy, as long as the 1031 Exchange Accommodator will cooperate and release the funds to the TDCO strategy, then the “failing” exchange can be rescued BEFORE it fails. It cannot be used to rescue an already failed exchange. Then, the taxes are deferred for decades as long as the investor follows the TDCO investment guidelines. Tragedy avoided!!!

Note: not all 1031 Exchange Accommodators cooperate with Capital Asset Dealers by releasing the funds to another strategy.

No Replacement Loan

In a 1031 Exchange, the investor is required to replace the debt on the previous property with an equal or greater debt on the newly purchased property. In some cases, this could present a problem if the investor finds out that their credit is not as good as they thought it was and now either don’t qualify or have to pay higher interest rates than they thought.

With the TDCO strategy, the previous debt is not required to be replaced. That is because the TDCO loan IS the replacement debt. One can simply pay off the debt and invest the balance of the resources as they desire.

Increased Depreciation

This section could be a whole article by itself so I’m going to keep it as simple as possible. In 1031 Exchanges, the depreciation schedule starts with the purchase of the first property. It ends 27.5 or 39 years after that purchase, depending on the type of property it is. That time clock continues to run, without resetting, with purchases of new properties through a 1031 exchange. The only increase in depreciation is any increase in value from the sale of one property to the value of another, with a new schedule on that increase. Any gains during ownership cannot be depreciated.

With the TDCO strategy, the investor sells their investment property and defers the capital gains and straight-line depreciation taxes for decades. They stop the 1031 exchange chain upon the sale of that property. When they purchase a new property, they will start a whole new depreciation schedule (27.5 or 39 years) based on the full depreciable value of the newly acquired property. This can be a significant tax advantage! 

Most of the time our Tax Strategists can find other situations going on in your financial life and actually hedge a strategy.  One of the nicest things about this type of strategy is the low cost to implement the strategy because we are using items already at play in your current tax situation.  

What Is Income Shifting?

Income shifting, sometimes known as income splitting, is a tax planning technique that transfers income from a high to low tax bracket taxpayers.   There are so many options in this strategy that it alone could create an entire business brokerage entity.

Breaking Down Income Shifting

Probably the best-known example of income shifting is the shift of unearned investment income from a high tax bracket parent to a low tax bracket child. Often this transfer is by a trust.

High to Low Tax Bracket Income Shifting 

Upper tax bracket, family business owners may shift income from business earnings distributions to low tax bracket relatives by hiring these relatives to work for the business and paying them salaries. The salaries are reported as business expenses if reasonable in amount and for work performed.  A greater amount of tax might be avoided by shifting ownership.

 Family limited partnerships (FLPs).  The business owner transfers business assets to FLPs and then sell, gift outright, or in trust, FLP interests to lower tax bracket relatives.

If your business is a C corporation and you plan ahead, you can sell your business to employees through an employee stock ownership plans (ESOP). The ESOP is owned by employees (find more information about ESOPs from the IRS). From an owner’s perspective you have captive buyers and don’t have to search around and is a very good reward to those that helped you get to this point. You set a reasonable price for the sale and receive cash from the ESOP. You can then roll over the proceeds into other investments to defer tax on the gain.

While the ESOP tax deferral does not translate for an S-Corp, you can always look at recategorizing the S-Corp. 

Owners who realize capital gains on the sale of their business  or appreciated asset have a way in which to defer tax on that gain if they act within 180 days of the sale. They can reinvest their proceeds in an Opportunity Zone. Deferral is limited because gain must be recognized on December 31, 2026, or earlier if the interest in the fund is disposed before this date. Holding onto the investment beyond this date can result in tax-free gains on future appreciation. An owner who sells his or her business doesn’t have to put all the proceeds into a QOZ, but tax deferral is limited accordingly. Find details about Opportunity Zones from the IRS.