Photo by Dimitri Karastelev on Unsplash
 

In last month’s newsletter, we covered year-end tax planning. This month, we take a deeper dive into a specific situation many of our clients face: mitigating the tax impact of an upcoming liquidity event.

Success is great, but it comes with a price: taxes. We’d all prefer success with taxes over failure without them, but what if you could succeed while minimizing taxes?

That’s where proper planning comes in.

Suppose you own a stake in a business, a private equity venture, appreciated stock or options, or a highly appreciated property you plan to sell in the future. What can you do to reduce your tax burden?
 

Direct Indexing with Automated Tax-Loss Harvesting

This strategy requires additional capital outside of the appreciated investment. If you have liquid funds, it can be an excellent tool to lower your tax bill. Here’s how it works: You invest in a broad range of stocks to approximate market performance. Since you own hundreds of stocks, some will decline during volatile periods, even if the overall strategy produces positive returns.

This creates opportunities to realize losses for tax purposes, even when your portfolio gains overall. During periods of volatility or bear markets, more losses can be harvested. The proceeds from these sales are reinvested so you can participate in market recovery, while locking in losses for tax purposes.

You can accumulate these losses for several years before your liquidity event, offsetting future gains and reducing your tax bill.
 

QSBS Exemption

If you own a stake in a C-Corporation, you may qualify for the Qualified Small Business Stock (QSBS) exemption, which can exclude up to $15 million (or 10x your cost basis) in capital gains per investor. Additional investors could include trusts you create, allowing you to “stack” the exemption multiple times and shield a much larger amount from taxes.

There are specific requirements for QSBS eligibility, so consult a tax attorney or accountant experienced with QSBS to ensure your entity is structured correctly. If your business is already a C-Corp, we can connect you with tax professionals who can provide a formal opinion letter confirming qualification. While these letters can be costly, the potential tax savings often justify the expense.
 

Spreading the Sale Over Time

By structuring a business sale as an installment sale, or gradually selling stock, you may stay within a lower tax bracket, reducing your overall tax liability compared to selling everything in one year.
 

1031 Exchanges

Real estate investors can defer taxes indefinitely through 1031 exchanges. Many hesitate to use this strategy because of the short timeframe to identify replacement properties and the challenge of selling and buying simultaneously.

However, 1031 exchange funds offer a solution: you can exchange your property proceeds into a professionally managed fund that owns multiple properties. This is ideal for investors who no longer want to manage properties or worry about finding suitable replacements.
 

83(b) Election for Restricted Stock or Options

If you’re confident your stock or options will appreciate, consider an 83(b) election. This allows you to pay taxes upfront on the current valuation, so future appreciation is taxed at the lower capital gains rate.

The risk? If the value declines, you’ve paid taxes on something that didn’t benefit you.
 

Donating Appreciated Positions to Charity

If you plan to give to charity, donate appreciated positions instead of selling them first. Selling triggers capital gains tax, but donating the positions gives you a charitable deduction for the full market value, and the charity pays no capital gains tax when selling.
 

Transferring Assets to Charitable Trusts

Charitable trusts can structure gifts in a tax-efficient way. For example:

• Charitable Remainder Trust (CRT): Transfer assets before a sale, receive a charitable deduction for the full expected value, and allow the trust to sell tax-free. The trust can then pay you an annuity for life or a set term, spreading out taxable gains.
• Charitable Lead Trust (CLT): Works in reverse: you commit to paying the trust an annuity and receive an upfront deduction for the expected value.
   

Buy and Hold Until Death

Sometimes, the best option is not to sell. This may make sense for family businesses or if you don’t need the proceeds during retirement. Upon death, assets receive a step-up in basis, meaning heirs can sell without paying tax on gains accumulated during your lifetime.
 

A Final Note

Additional techniques include intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs), deferred sale trusts (DSTs), and more. The right strategy depends on your goals, needs, and desired level of control.

Planning well in advance of a sale can save significant taxes and give you confidence moving forward. We recommend starting with a comprehensive financial plan, which can then be integrated into estate and tax strategies tailored to your situation.

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