Significant tax and investment challenges are associated with managing a portfolio of individually owned stocks that have embedded long-term capital gains but lost value due to recent drops in the U.S. equity markets.
Consider this. The U.S. equities market seems to be on the edge of a correction, and individual investors may consider selling some positions to reduce their allocation of equities by locking in current values. This may be wise investment planning. Even though these positions show losses in value from where prices were weeks ago, the sales will still generate taxable long-term capital gains. This may be an uncomfortable scenario for many reasons, one being the tax cost, which makes the “loss of gains” even more financially painful.
Consider some philanthropic alternatives. Avoiding income taxes on long-term capital gains is a hallmark of charitable planned giving. Banking gains through gifts of appreciated securities enable donors to realize significant tax benefits. For outright gifts to public charities, donors can make transfers of appreciated securities for their contributions instead of using cash gifts. By making gifts of appreciated property, the donor generates a full value deduction for the transfers and pays no tax on the long-term capital gains.
In the current scenario of a down market, let’s assume that the donor is determined to extract some highly appreciated stocks to reduce portfolio risk. This donor may be unwilling to cede ownership of the net value of the shares even after capital gains taxes. However, the donor may be interested in a plan that provides a stream of income for life/lives and leaves the full or partial value of the contributed shares to benefit the next generation within the family. We can create that plan by using a type of Charitable Remainder Trust (CRT).
Assume an assembly of appreciated securities with a current value of $500,000 and a cost basis of $50,000. The taxable gain for these securities would be $450,000. The stocks may be transferred to the CRT with no initial tax on the long-term capital gains. The CRT now has a collection of securities worth $500,000, which it sells (at no capital gains tax cost). The CRT is structured to make fixed-rate lifetime payments to one or more individuals at a stated rate, which may not be lower than 5%. At the outset, the donor has tax savings resulting from the front-end income tax charitable deduction and the avoidance of initial capital gains taxes. Payments continue for life/lives and, over time, may equal or exceed the total value of the securities when contributed to the CRT.
Finally, CRTs may provide for surviving family members. The beneficiary/ies of the annual CRT payments may be able to allocate some of those funds to pay the annual premiums on a life insurance policy owned by an irrevocable life insurance trust. The life insurance trust will pay a death benefit after the donor’s lifetime for the benefit of heirs, free from the payment of federal estate taxes. This will require a financial plan designed by an insurance professional.
This philanthropic plan enables the donor to earn lifetime income, generate income tax savings through the charitable deduction, leave the assets in the trust to charities when it ends, and provide replacement value for heirs.
Please contact us for more information about this plan and other opportunities at
plannedgiving@afhu.org or 212.607.8524.
