It was once said that tax mitigation involves the use of tax laws to achieve anticipated tax advantages embedded in tax provisions. We are firm believers in that statement. Our clients do not look to evade taxes but ask us to evaluate and introduce a number of the following techniques to mitigate potential taxable events in their lives.
Real Estate Related Concerns--Capital Gains
Delaware Statutory Trust
DST investments are offered as replacement property for accredited investors seeking to potentially defer their capital gains taxes through the use of a 1031 tax-deferred exchange and as straight cash investments for those wishing to diversify their real estate holdings. The DST property ownership structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property along with other investors, not as limited partners, but as individual owners within a trust. Each owner receives their percentage share of the cash flow income, tax benefits, and appreciation, if any, of the entire property. DSTs provide the investor with the potential for annual appreciation and depreciation (tax shelter) and most have minimum investments as low as $100,000, allowing some investors the benefit of diversification into several properties.
Why haven't you heard about self-directed IRAs? The answer is pretty simple. Do you have your assets held with custodians like Merrill Lynch or Charles Schwab? If so, a self-directed IRA goes against their corporate mission because they sell financial products like securities, CD's, bonds, and other instruments that trade on public exchanges. That is how these types of custodians are compensated. Think about it... they do not receive compensation when you invest in real estate in your IRA, so why would they want to offer that to you as a client of their firm?
Some popular self-directed investments within a self-directed IRA are listed below. Depending on your IRA custodian, you may invest in real estate such as residential homes, condos, office buildings, foreclosures and even foreign real estate, but a self-directed IRA allows you to invest in almost any alternative asset including tax liens, hard-money loans, notes, private companies, hedge funds, startups, IPOs, foreign currencies, peer-to-peer lending, crowdfunding ventures and much more. With that being said, SDIRAs can be a very strategic means for you to invest and defer your capital gains and dividend taxation just like a traditional IRA.
More information regarding self-directed IRAs can be found at this IRS.GOV link
A 1033 exchange requires a taxpayer (either an individual or a business) to make a timely election and a timely replacement to defer gain on real property following an involuntary conversion which is when the property is completely or partially destroyed, for example, by fire or natural disaster. A gain often results when the taxpayer receives an insurance settlement for more than the property’s cost basis. Taxpayers may make elections after they have filed the tax return for the year in which they receive the insurance proceeds (subject to time constraints).
Learn more by visiting this IRS. GOV link related to Memorandum No. 200147053, released date 11.23.2001
Broadly stated, a 1031 exchange (also called a like-kind exchange) is a swap of one investment property for another. Although most swaps are taxable as sales, if yours meets the requirements of 1031, you will either have no tax or limited tax due at the time of the exchange.
In effect, you can change the form of your investment without (as the IRS sees it) cashing out or recognizing a capital gain. This allows your investment to continue to grow tax-deferred. There is no limit on how many times or how frequently you can use a 1031 exchange. You can rollover the gain from one piece of investment real estate to another to another and another. Although you may have a profit on each swap, you avoid tax until you sell for cash many years later. Then, you will hopefully pay only one tax, and that at a long-term capital gain rate (currently 15% or 20%, depending on income—and 0% for some lower-income taxpayers).
Listed Public Securities Related Concerns--Capital Gains
Qualified Opportunity Zones
Opportunity zones are designed to spur economic development by providing tax benefits to investors. First, investors can defer tax on any prior gains invested in a Qualified Opportunity Fund (QOF) until the earlier of the date on which the investment in a QOF is sold or exchanged, or December 31, 2026. If the QOF investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain. If held for more than 7 years, the 10% becomes 15%. Second, if the investor holds the investment in the Opportunity Fund for at least ten years, the investor is eligible for an increase in the basis of the QOF investment equal to its fair market value on the date that the QOF investment is sold or exchanged.
Maltese Pension Plan
We work with the top tax law and asset protection attorneys across the country. During a recent discussion with one of these attorneys, we were informed about the unique benefits afforded to US citizens via the U.S.-Malta income tax treaty (the “Treaty”) in November of 2010). In contrast to the stringent limitations imposed on contributions to Roth IRAs under U.S. law, unlimited contributions may be made to a Malta pension plan. The best way to describe the benefits of such a plan is in the example below.
Assume a U.S. resident individual 49-years of age owns both highly-appreciated U.S. real estate and founders’ shares of a technology start-up that is about to go public. In combination, the interests are worth approximately $100 million, and the aggregate tax basis of the assets is $10 million. As part of her retirement planning, this U.S. individual decides to contribute these assets to a Maltese pension fund. During this same tax year, the real estate is sold for fair market value and the technology company goes public though she is required to hold the shares for at least 6 months before disposing of them. During the following tax year, after her lockup period expires, she sells her shares for fair market value thereby leaving her portion of the pension plan holding proceeds of $100 million. Since, at this time, she is at least 50 years of age, assuming the terms of the pension plan permit her to begin withdrawing assets at age 50, the U.S. individual can cause the pension plan to distribute to her during that tax year $30 million of the pension plan funds without the imposition of any tax, either in Malta or the United States.
At this point, the pensioner would need to wait until year 4 to be able to extract additional profits tax-free (pursuant to Maltese law, three years must pass after the initial lump sum distribution before additional lump sum distributions could be made to a resident of Malta tax-free). Thus, in year 4, additional assets can be distributed to the member without triggering tax liability. To calculate how much can be distributed free of tax, it is necessary to first determine the pension holds “sufficient retirement income.” This amount in turn is based, pursuant to Maltese law, on the “annual national minimum wage” in the jurisdiction where the member is resident. To the extent the pension plan balance exceeds the member’s “sufficient retirement income” (on a lifetime basis), 50% of the excess can be withdrawn tax-free each year. Assuming the $70 million remaining assets (after accounting for the initial lump sum distribution) had increased in value to $85 million by year 4, and further assuming it was determined that the individual needed $1 million as her sufficient retirement income, 50% of the $84 million excess, or $42 million, could be distributed to her that year free of tax. Such calculations could likewise be performed in each succeeding tax year, with 50% of the excess being available for tax-free receipt by the beneficiary each year. Consequently, while it is not possible to distribute 100% of the proceeds of such a pension tax-free, a substantial portion of any income generated in the pension (including gains realized with respect to appreciation accrued prior to contribution of assets to the pension fund) may be distributed without any Maltese or U.S. tax liability.
 Note that, as discussed above, there should be no U.S. tax implications on contribution of the assets (for example, under Section 684), as the pension plan should be classified as a grantor trust for U.S. federal income tax purposes.
For more information on this plan, visit this IRS.GOV link.
Required Minimum Distributions Related Concerns
Qualified Leveraged Strategy
For many clients qualified plan balances such as IRAs, 401(k)s, 403(b)s, etc. can represent a significant portion of their wealth. Unfortunately, these balances are subject to significant federal and state income taxes, federal estate taxes, and possibly the imposition of a 10% penalty for early withdrawal if the participant begins taking distributions from the plan prior to attaining age fifty-nine and one-half (59 1/2). The Qualified Leverage Strategy uses a permanent life insurance contract to reduce the tax burden on the plan assets, potentially providing additional assets to the participant's beneficiaries outside of their gross estate. The QLS may further reduce the overall tax burden on the participant and their heirs through a strategic Roth conversion. This is completed through the use of time-tested strategies approved by the Internal Revenue Service and the Department of Labor when organized in a unique way.
IRS Circular 230 notice: In order to comply with requirements imposed by the IRS, I must inform you that any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.