The Investment Scientist

Archive for July 2018

adhesionactif.jpgAfter my last article, “How to Deal with ConcentratedHighly Appreciated Position,”a reader asked me exactly how much he can save in taxes.

I’ll use  him as an example. He owns an investment property that he bought many years ago for $200k that is now worth $800k.

If he sells his investment property outright, he will need to pay a capital gain tax of the amount (800-200)*20% = $120k.

He can set up a CRT (charitable remainder trust), put the property in it , so when he sells it, the capital gain tax is exempt. That’s a savings of $120k right there.

But does he need to give all of that to charities? The answer is no. In fact he can take out money from the trust for his personal use.

Depending on how he takes out money, a CRT can be either a CRAT (charitable remainder annuity trust) or a CRUT (charitable remainder unit trust.)

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141223130506-charity-stocks-1024x576.pngAfter my last newsletter article “Top Ten Reasons to Avoid Exchange Funds” went out, I got an email asking how to deal with a concentrated highly appreciated stock position. To this, I replied, “It helps to have some charitable inclination.”

If you have no charitable inclination, no amount of gimmicks can get you off the hook of paying the huge capital gain taxes. At best, you can pay a hefty fee to have someone kick the can down the road by using exchange funds.

However if you are charitably inclined,  then a charitable remainder trust (CRT) is a great tool to save on taxes, reduce undiversified risk, create income and  benefit charities.

What is a CRT?

A CRT is a trust that lets you convert convert a highly appreciated asset like stock or real estate into lifetime income. It reduces your income taxes now and estate taxes when you die. You pay no capital gains tax when the asset is sold. And it lets you help one or more charities that you care about.

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Tojas_eltort.jpgA few days ago, I was approached by an employee of Nvidia regarding his $5mm worth of NVDA stock. A Morgan Stanley broker had pitched him the idea of using exchange funds to diversify his holdings and he wanted my second opinion.

If you are an employee of any of those high flying tech companies like Amazon, Facebook, Google, Apple, Microsoft, Netflix, and etc., you are likely to have been pitched such an idea. Talk to me before you execute anything.

So what exactly are exchange funds? Exchange funds are unregistered private-placement limited partnerships or LLCs designed specially for investors with concentrated positions in highly appreciated stocks to help them diversify without triggering taxes.

How do they work? Investors transfer shares of their concentrated stocks to the fund in exchange for an equal value of units of the fund. These transfers are not taxable since they are considered partnership capital contributions under the tax law. There are a few caveats to the law though: investors have to stay in the fund for a minimum of seven years and the fund must invest 20% of its capital in illiquid assets.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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