How to Pick the Best Capital Gains Tax Deferment Strategy
Over the past 5 years, I have talked to many investors about various experiences with tax strategies. For some, they have been very successful at leveraging tax strategies for their assets. For others, tragedy. Tragedy because either they missed out on an opportunity that they did not know about or tragedy because they chose a strategy that did not really fit what they needed. In this brief article, I will go over some important things to consider when choosing a capital gains tax deferment strategy. Before I get into the 3 key components I look at, we need to be reminded that tax planning is always better than tax reaction. Planning happens before the sale, sometimes a significant amount of time ahead of a sale. Tax reaction is when a client is scrambling to put something together because they are already in the process of a sale. Planners have more options to choose from. Reactors have less options. There are three things that need to be considered in picking a tax deferment strategy: Numbers, Goals, and Personality. Most of the time, looking at these three issues will help a client to hone in on what is best.
NUMBERS
Tax deferral strategies, most of the time, come with a cost. Among the least expensive is a 1031 Exchange. Among the more expensive are various types of tax mitigation or deferment trusts. Each investor ought to start by sitting down with their tax professional to get a reasonable estimate of taxes to be paid upon the sale of the asset. Once that is determined, then it is easier to answer the question: “does it make sense to spend this much money for a transaction as compared to the expected cost of taxes?” If one cannot really leverage the difference between the projected tax bill and the cost to do the strategy to grow the estate, then it is not worth it.
GOALS
Goals are really critical for tax planning. Each tax strategy has a long term commitment whether it’s the tax reporting, the nature of when and how much funds they receive, when the capital gains taxes actually come due, and so on. There needs to be a consideration of the long term commitment alongside of one’s personal goals. Too often, investors just assume that there are no options that meet their real goals so they just pick what they think is best. By understanding one’s goals, and doing advanced tax planning, it may be easier to accomplish those goals than they realized. Write down the goals. Understand that if your goals are to use money for personal use (pay off primary home mortgage, buy a car, etc), then the government wants their money because you are using yours for personal use. However, don’t assume that there are no options to accomplish your goals. There may be. When you speak to a capital gains strategist, make sure you’re honest about the nature of your goals so that they can better help you to find a good fit; if at all possible.
PERSONALITY
Personality is critical in decision making. For some, they leverage every penny they can to grow their estate via tax strategies. For others, the cost and commitment is not something they want to have hanging over them for multiple years, so they’ll simply pay the tax. The former will often look at the latter and say that they are foolish. In the end, it’s not a maturity issue as much as it is a personality issue. When you are done with your tax planning, you need to have peace of mind that you did what you are comfortable with. In some cases, taking the gut punch by paying the taxes is a relief because there are no long term commitments, etc. For others, there is no way they’ll pay the tax at that time so they need a tax deferral strategy. Stay true to who you are and make sure you have a clean conscience about the decision you make. Lastly, always seek the counsel of tax professionals and attorneys to make sure that what you are looking at is a good fit for you. Having a team that supports your decision can be very helpful in case you get audited in the future.