CASE STUDIES: TAX ADVANTAGED INVESTING

CASE STUDY # 1: USING CHARITABLE CONTRIBUTIONS OF A CONSERVATION EASEMENT, IRC § 170(h); A tax-mitigation Strategy for Ordinary Income

A Charitable Contribution of a Conservation Easement (CE) may be used to mitigate taxes due to ordinary income.

A CE can occur when a property owner gives up a viable right (such as a development, or a mineral right, etc.) associated with a property in perpetuity, via easement, that is monitored by an NGO or government entity, as long as it creates a public benefit.

The CE is structured as a real estate investment that has three operational and exit strategies one of which is voted to be the strategy that will be used by the investors. Generally, the strategies are:

  1. Hold the property for appreciation,
  2. Develop the property to its highest and best use, or
  3. Create a Conservation Easement.

To determine the value of the conservation easement, two MAI appraisals of the subject property, meeting specific governmental criteria, are completed: the first appraisal is the before condition of the property’s highest and best use, the second is the after condition of the property’s highest and best use.  The difference in value between the first and second appraisal may provide a tax deduction to the investor.

The tax benefits generated by a Conservation Easement are limited to 50% of adjusted gross income (AGI). Historically, the economics of a CE are such that for a $1 contribution into the CE, an investor’s income is reduced by approximately $4.00. At a 39.6% tax rate, for every $1 contributed, the investor’s taxes may be reduced by approximately $1.60.

It should be noted the IRS is aware that Conservation Easements are subject to abuse because of the tax benefits received. The IRS put forth Notice 2017-10 January 23, 2017 to address these issues. CEs are now listed transactions. In the event the deduction is equal or greater than 250% of the amount invested, they are subject to further scrutiny and potential audit as being abusive. The CEs referenced in this case study have a deduction of approximately 1.6 to 1. Furthermore, in an abundance of caution, the sponsor has recently sought to get tax loss insurance on all CEs going forward. They have been successful in obtaining that insurance for all CEs since that decision.

As with any tax strategy, clients should consult with their tax professional. Neither IREXA, LLC nor the Sandlapper Group of companies are attorneys or tax professionals. All work regarding Strategic Tax Mitigation™ relies on collaboration with a tax professional.

 

CASE STUDY # 2: REDEPLOYING TAX SAVINGS FROM A CONSERVATION EASEMENT TO PROVIDE TAX FREE RETIREMENT INCOME

A married couple in their mid-forties approached me to have a financial analysis based on my Strategic Tax Mitigation™ protocol. Their chief concerns included: the lack of strategies they had to reduce their current taxes and to develop a better retirement income program. After the review, I developed a plan to meet the clients’ goals and objectives.

  1. The clients currently generate approximately $467,000 annual income.
  2. The clients each have older Variable Universal Life (VUL) Insurance policy

With regards to income, a Charitable Contribution of a Conservation Easement (IRC § 170h) could be used to reduce taxes due to Ordinary Income (see Conservation Easement case study). In this couple’s case, a tax savings of approximately $24,500/yr could be achieved. Using this strategy, their taxes could be reduced from $123,500 to $99,000 in the proposal year.

With regards to their life insurance policies, Variable Universal Life policies follow the market. Cash values in the policy can go up or down depending on the direction of the market. When I explained the volatility issues the clients also became concerned. The policies were out of date and didn’t meet the clients’ desire for creating additional income in retirement.

The following proposal was made:

Generate tax savings from the use of the conservation easement, then redeploy the savings to invest in a better life insurance policy. The tax savings from the Conservation Easement could be used to help create a life insurance policy more aligned with the clients’ goals and objectives.

The existing VUL insurance policy was converted into an Indexed Universal Life (IUL) insurance policy by using a IRC § 1035 exchange. The clients were lawfully able to make this exchange without paying taxes. The two VUL policies had a cash value of approximately $200,000. The annual $12,000 premium for both clients was increased by $18,000 for a total of $30,000/yr, using most of the annual savings from the Conservation Easement. The CE acquisition and tax savings is repeated annually. As long as the couple’s income stays above $400,000, the new life insurance policy should be fundable from the Conservation Easement savings, with no additional money from the clients.

Through the Indexed Universal Life policies, the clients may be able to create $161,541 per year tax-free retirement income for 25 years (65 to 90). The total cost of the policies is $830,000. If the clients survive for just over 5 years into retirement, they will have gotten their money back. If the clients live long enough to use all of the tax-free income available in the policy, they should be able to withdraw over $4,038,500, or nearly 5 times their cost.

As with any tax strategy, clients should consult with their tax professional. Neither IREXA, LLC nor the Sandlapper Group of companies are attorneys or tax professionals. All work regarding Strategic Tax Mitigation™ relies on the client’s tax professional.

Tax free Retirement

 

CASE STUDY # 3: A 1031 EXCHANGE THAT BECAME A CONSERVATION EASEMENT TO FUND PART OF AN ESTATE PLAN FOR ESTATE TAX OFFSET

In a recent consultation, a high net worth individual told me he inherited property in the middle of the country. The property was worthless until they found oil. He received an offer on the property, the net price of which was $9,000,000. The client was interested in deferring his taxable gain.

He was not happy about the value and sale because of the tax consequences. He had gifted to his children the maximum amount allowed. So, instead of a $9 million gain he had created a $4,500,000 tax liability for his heirs.

Using the following assumptions:

  • The couple’s income of $1,500,000 was increased by $540,000 following the acquisition of the 1031 replacement property, for a total annual income of $2,040,000.
  • Husband and wife are both in their early 70s.

The following proposal was made:

  • By using a Charitable Contribution of a Conservation Easement to offset ordinary income, the estimated annual tax savings was approximately $181,000.
  • The $181,000 tax savings in combination with an additional $8,500 for a total of $189,500 was used to purchase a Second-to-Die, Indexed Universal Life insurance policy. The policy had a death benefit of approximately $10,000,000.00.
  • The insurance policy was structured as an Irrevocable Life Insurance Trust ILIT to get the policy proceeds outside of their estate. This created an additional gift tax on the premium.

The net result was that for nominal costs to the couple, their heirs could receive sufficient proceeds to offset the original estate tax liability as well as leaving their heirs with an additional $5,500,000 that could be used to offset further growth in the parent’s estate.

As with any tax strategy, clients should consult with their tax professional. Neither IREXA, LLC nor the Sandlapper Group of companies are attorneys or tax professionals. All work regarding Strategic Tax Mitigation™ relies on collaboration with a tax professional.

ESTATE TAX

CASE STUDY # 4: TAX-ADVANTAGED INVESTING

CLIENT: A high net worth business owner with a significant income stream who is starting to explore estate-planning issues.

STRATEGY: The client owned two adjacent commercial properties in a major metropolitan area. One of the properties was purchased to develop and relocate the client’s expanded business. It was eventually deemed surplus and sold via a 1031 exchange. Due to the financing, all loans were paid off at closing leaving relatively small amount of sales proceeds before taxes. Since the lender agreed to refinance the retained property to the same debt level as before the exchange, funds were available not only to complete the exchange, but additional funds remained for further investment.

After reviewing the client’s tax returns in collaboration with her CPA, we determined that the additional funds could be used to: reduce the client’s effective marginal tax rate, and fund a plan that would produce tax free retirement income. An analysis showed her effective marginal tax rate could be reduced from 33.7% to 21.1% with a tax savings of $132,700.

A substantial portion of this strategy could be replicated annually, as long as tax regulations remain relatively consistent. The first area of interest was ordinary income. The solution involved the use of a charitable contribution (IRC Section 170h) to directly impact taxes at the ordinary income level. The next area of interest was rental and royalty income. The solution involved the use of depreciable assets to minimize the impact of rental income.

RESULTS: The client was able to reduce her effective marginal tax rate and realize substantial tax savings as a result of employing the recommended solutions. Furthermore, the client redeployed the savings into an insurance based retirement plan that, upon full funding of the program, would provide tax free retirement income for life.

By using assets that are not well known, and are typically non-public, we target specific areas of the tax code and take maximum advantage of those codes for the benefit of and in conjunction with a client’s specific financial objectives.

ADDITIONAL READING

Whitepaper: Opportunities for STRATEGIC TAX MITIGATION

How we use specific sections of the tax code to mitigate taxes for accredited investors.

©2016 IREXA Financial Services | Wealth Strategies. All Rights Reserved. Privacy Policy

All investments involve risk. Outcomes are not guaranteed.

*IREXA Financial Services | Wealth Strategies, SANDLAPPER Securities, LLC and Sandlapper Wealth Management LLC do not provide legal or tax advice.

**Investing has risks; performance is not guaranteed. Securities offered through SANDLAPPER Securities, LLC (member FINRA/SIPC) and advisory services offered through Sandlapper Wealth Management, LLC an SEC Registered Investment Advisory Firm. Robert Boggess is an independent representative of SANDLAPPER Securities and independent advisory representative of Sandlapper Wealth Management. IREXA Financial Services/Wealth Strategies is not an affiliated company with the Sandlapper Companies or CPAAcademy.org. No offer to buy or sell securities is being made. Such offers may only be to qualified accredited investors via private placement memorandum. Neither Sandlapper nor IREXA are tax advisors. Prospective strategies and products used in any tax advantaged investment planning should be reviewed independently with your tax and legal advisors. Investments are not guaranteed or FDIC insured and risks may include but are not limited to complete loss of principal investment. Risks detailed in a private placement memorandum should be carefully reviewed, understood and considered before investment. Changes in the tax code and other regulatory revisions could have a negative impact upon strategies developed and recommendations made.

Risk Disclosure: Alternative investment products, including real estate investments, notes & debentures, hedge funds and private equity, involve a high degree of risk, often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor's interest in alternative investments, and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-U.S. exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in U.S. markets. Additionally, alternative investments often entail commodity trading, which involves substantial risk of loss. NO OFFER OR SOLICITATION: The contents of this website: (i) do not constitute an offer of securities or a solicitation of an offer to buy of securities, and (ii) may not be relied upon in making an investment decision related to any investment offering by IREXA Financial Services/Wealth Strategies, SANDLAPPER Securities, LLC, or any affiliate, or partner thereof (“Sandlapper”). IREXA Financial Services/Wealth Strategies does not warrant the accuracy or completeness of the information contained herein.

FINRA Broker Check: Check the background of this investment professional on FINRA BrokerCheck.