You have made some great investments in Real Estate or in a Stock Portfolio. Congratulations! Now you are ready to retire on your gains. But wait. To benefit from your investment appreciation, you're going to have to sell some or all of those assets.
If you sell your investment property, you will need to pay capital gains tax to the Federal Government, State, and you will also pay recaptured depreciation. If you're in California, add another 3 1/3% in withholding. That's a huge chunk of change, and a big blow to your savings.
If you sell your stocks, you'll be giving up at least 15% to capital gains. There is also no guarantee that the long term capital gains rate will remain at 15% forever. It could increase down the road.
How can you start receiving income but not get hit with huge amounts of tax?
For real property, there is a 1031 exchange into a tenant in common property. This works well for investors that don't want to manage property anymore, but still enjoy the benefits of real estate ownership. This is a subject covered in many of my previous articles.
There is another powerful concept. It's called a Private Annuity Trust. These trusts have been around since 1939, but until the last few years have primarily been used for Estate Planning purposes. The Private Annuity Trust also works extremely well for Retirement Planning. It is fairly complex to set up and administrate, so many financial planners, real estate brokers, CPAs and Attorneys still don't know much about them.
The procedure is basically this.
1. A Private Annuity Trust is established. You, the seller become the annuitant.
2. A fair market appraisal is done to determine property value.
3. The seller can negotiate a sale price at the appraised value.
4. The property is transferred to the trust and the trust is now the seller of the property and retains the proceeds.
5. The proceeds are invested by trustees (not the annuitant) and an arrangement is made to pay the annuitant (and perhaps their spouse) in monthly payments for the remainder of their lives. The capital gains tax is spread out over the course of your lifetime. If you pass away before your estimated average calculated life span, the remainder of the assets pass to the beneficiaries. The balance will be passed free of Estate Tax, Gift Tax, Generation skipping tax, and Transfer tax. Any capital gains tax still due will be paid before disbursement.
6. Other properties or stocks can be added to the trust at a later time, and recieve the same benefits.
As an example, let's say you have a million dollar gain on a property. You might very well owe 350K in taxes. With a Private Annuity Trust, all one million goes to work for you, and you can receive montyly income for the rest of your life. The exact amount is determined by your age and the time you choose to begin receiving your payments. You have the option to defer receiving payments until the age of 70 1/2. This allows the assets to grow compounding and tax deferred, and allows for greater income in the future.
The trust removes the assets from your estate, as the trust now owns them and the annuitant relinquishes control over how they are invested.
Setting up a Private Annuity Trust can definitely give a turbo boost to your retirement bottom line. Ask yourself, would you rather give a "gift" to the government in a big lump sum, or would you like to pay in small chunks and have the bulk of your profits working for you and earning compounded interest for years to come?
