Capital Gain Considerations

"We know that the house in Lake Tahoe is your happy place, so your mother & I would love to gift this property to you & your family". Waterfront property in the majestic Lake Tahoe... what a generous gift! 🏡 But what if our children decide to settle down on the East Coast & we want to be closer to them? This was a question one of my clients was grappling with after his parents expressed their desire to give him the family vacation property in Lake Tahoe. My client's parents knew that the Tahoe home was their son's "happy place" and they wanted him & his family to be able to experience many wonderful memories at this place. His parents were also seeking to proactively get their estate plan in order. My client was thrilled by the opportunity to receive the gift of Tahoe Home that he has fond memories of while he was growing up. He asked me, "Chris - is there anything that we're not thinking about before accepting this gift?" I'm sure glad he shared this with me & raised this question! Turns out, his parents originally acquired this property in the early 2000's for $240k. Based on recent home sales nearby, the current value of the home is likely north of $4M. Given the significant appreciation, I cautioned that if he accepted this property as a gift, he would take over the donor's adjusted basis of the property. Adjusted basis = purchase price + any home improvements. Since the adjusted basis is so low relative to what this home is currently worth, this could result in significant tax consequences if my client chose to sell this property in the future. Whereas, if my client received this home as part of his inheritance (upon death of the original owner), then he would acquire the property with a "stepped-up" cost basis. The step-up in basis would result in my client acquiring the Tahoe home for the Fair Market Value on the date of death (i.e. ~$4M), therefore eliminating $3.5M of embedded capital gains & $800k+ of taxes upon the eventual sale of this property. I also raised the opportunity that if his parents are seeking to do estate planning for their personal situation, there are some advantageous methods of gifting property from a tax perspective, such as a Qualified Personal Residence Trust. This type of trust shifts the residence to "outside the estate" of his parents & can help reduce the amount of gift tax that would be incurred when transferring assets to a beneficiary. Given what is at stake, we agreed to have a three-way meeting with my clients & his parents to discuss the objective for the Tahoe Home and the most effective way to accomplish this goal. Inheriting a $4M property in beautiful Lake Tahoe is certainly a fortunate "problem" to encounter. However, the purpose of sharing this post is to highlight the importance of communication between individuals & their advisor, as well as the potential benefits of thoughtful planning around multi-generational gifting.

You already know donating appreciated stock is a great way to avoid recognizing capital gains, but here’s something I've never seen mentioned: It’s also a simple, effective way to step up the basis of your investments. Let’s break it down into three scenarios: Scenario A: What many people do: Give cash, keep the stock You donate $10,000 cash and keep $10,000 in stock with a $7,000 basis. If the stock grows to $12,000, your basis is still $7,000. You’ve helped the charity, but your investments haven’t changed. Scenario B: Typical advice—gift stock (implied/unmentioned: keep cash) You donate $10,000 of appreciated stock instead of cash, avoiding capital gains on the $3,000 of growth. This is where the advice stops... there's no mention of the cash you would have given... it seems implied that you do nothing with it because no one said what to do with it. So you keep your $10,000 cash, but your stock is gone. This avoids taxes, but you’re left with less invested. Scenario C: The best advice—gift stock, replenish with cash You donate $10,000 of appreciated stock and avoid the $3,000 capital gain. Then, you use the $10,000 cash you would have donated to repurchase the same stock. Now, you have $10,000 of stock with a $10,000 basis. Over time, this strategy systematically steps up your basis. For example: Year 1: Your $10,000 stock grows to $12,000. Instead of holding stock with a $7,000 basis, it now has a $10,000 basis. Year 2: Repeat the process. You’ve reduced future taxable gains while still supporting your charity. Why it matters: This simple adjustment ensures the charity receives the same $20,000 over 2 years, but you've stepped up your stock basis from $7,000 to $11,667. Of course, this strategy makes sense if: 1:You’re already charitably inclined. 2:Your giving amount justifies the extra step. Because you shouldn't let taxes drive your decisions... you should use strategies that align with your goals. This is a win-win for you and your portfolio as well as the charity you support!

You don’t always get to exclude all your capital gains when selling a former rental home. Here’s why. A common misconception I hear: “As long as I live in the property for 2 years before I sell it, I get the full $250K/$500K capital gain exclusion, right?” Not necessarily. If you rented the home first, especially after 2008, and then converted it to your primary residence, part of your gain could be taxable under the IRS’s nonqualified use rule. Here’s the catch: Any period of time the home was a rental before it became your primary residence is considered nonqualified use, and the gain from that portion cannot be excluded under Section 121. Example: Owned for 5 years Rented for the first 3 years Lived in it for the last 2 years $100,000 gain on sale 60 percent of the gain is taxable 40 percent may be excluded And depreciation is always taxable, no exceptions. If you’re planning to sell a property you once rented out, talk to a tax professional first. You might not owe what you think, or you might owe more.

Earnouts are common in M&A, but understanding how they are taxed is RARE. Let's cover the top two most common tax issues for earnouts: treatment as ordinary income, and accelerated gains in the installment method. 1️⃣ 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐆𝐚𝐢𝐧 𝐨𝐫 𝐎𝐫𝐝𝐢𝐧𝐚𝐫𝐲 𝐈𝐧𝐜𝐨𝐦𝐞 There are two potential tax treatments for an earnout payment in a stock sale: 1) capital gains and 2) ordinary income. Given that capital gains + NIIT is 23.8% and the highest marginal ordinary tax bracket is 37%, most owners would prefer capital gains treatment because of the ~14% savings. The tax treatment of an earnout is based on whether the IRS views the payment as compensation (ordinary income tax) or part of the purchase price (capital gains tax). To avoid treatment as compensation (ordinary income tax), sellers should ensure the following: 1. Payments should be linked to company performance, not personal performance. 2. Payments should not be comparable to typical compensation for a seller's role & seller should separately receive market compensation for their role. 3. Payments should not be contingent on seller's employment (i.e., earnout can be paid if seller is terminated) & the term of the earnout should not be tied to the term of a seller's employment agreement. 2️⃣ 𝐈𝐧𝐬𝐭𝐚𝐥𝐥𝐦𝐞𝐧𝐭 𝐌𝐞𝐭𝐡𝐨𝐝 The installment method under Section 453 allows sellers to spread the recognition of capital gains over the period they receive payments, rather than paying all taxes upfront 😁. However, the IRS assumes the maximum potential earnout will be received in the shortest time possible when calculating the taxable portion of each payment (using gross profit ratio) which can accelerate gain recognition 😢. This can result in sellers paying taxes on income they haven't yet received. For example: Basis: $1M Purchase Price: $10M Earnout: $5M Gross Profit Ratio with Earnout: $14 / $15 = 93% of payment is taxable Gross Profit Ratio without Earnout: $9 / $10 = 90% of payment is taxable While you still won't be taxed for more than the payments you actually receive, the accelerated recognition can increase your tax burden earlier than expected. --- This is provided for informational purposes only. Consult your tax advisor. Follow me for more thoughts, explanations, and stories, in the world of small business acquisition.

We have successfully done a number of OZ deals, and as end of year tax planning occurs we have been getting questions from investors. I'll share what I just sent out: Here’s how the types of capital gains and tax benefits work with Qualified Opportunity Zone Funds (QOFs): Types of Gains: 1. Short-Term Capital Gains: Gains from the sale of assets held for one year or less. These are typically taxed at your ordinary income tax rate, which can be as high as 37%. 2. Long-Term Capital Gains: Gains from the sale of assets held for more than one year. These are taxed at lower rates, typically 15% or 20%, depending on your income level. When you invest in a QOF, you can defer paying taxes on either type of capital gain (short-term or long-term), as long as you reinvest the capital gain portion of the sale proceeds within 180 days. Breakdown of the Tax Benefits: 1. Tax Deferral on Capital Gains:You can defer paying taxes on your capital gains (from stocks, bonds, or other investments) until the earlier of two events: the date you sell your interest in the QOF or December 31, 2026. This deferral applies to the capital gain portion you reinvest in the QOF. 2. Partial Forgiveness of the Deferred Gain:If you hold the investment in the QOF for at least 5 years, you get a 10% reduction on the deferred capital gain tax liability. If you hold it for 7 years, you get an additional 5% reduction, bringing the total tax reduction to 15%. For example, if you had $100,000 in capital gains, after 7 years in a QOF, you would only owe taxes on $85,000 of that gain. 3. Permanent Exclusion of New Gains:After holding the QOF investment for 10 years, you are eligible for a 100% tax exclusion on any new capital gains generated from your QOF investment. This means that if your real estate investment within the QOF appreciates, you will pay no capital gains taxes on the appreciation if the investment is sold after 10 years. Example: - You sell stock for a $100,000 long-term capital gain in 2024 and reinvest it in a QOF.Normally, you would owe $20,000 in taxes on that gain (assuming a 20% long-term capital gains rate). By investing in a QOF, you defer paying that $20,000 in taxes until 2026. If you hold the QOF investment for 5 years, your taxable gain is reduced by 10%, meaning you now only owe taxes on $90,000 of the original gain. If you hold for 7 years, your taxable gain is further reduced by 5% more, meaning you only owe taxes on $85,000 of the original gain. If you hold the investment for 10 years, any new gains on the investment (from the real estate development) are completely tax-free. So, while you can’t entirely eliminate the tax on the original gain (except for the 15% reduction), the major incentive comes from the potential to eliminate taxes on all future appreciation from the QOF investment after holding it for 10 years.

Selling an investment property that's gone up in value? You need to plan for the income tax impact. There are a lot of different taxes to contend with upon sale -- including the often-overlooked "depreciation recapture" at a 25% tax rate -- assessed on all straight-line depreciation taken to date. Take this example below, with a Single NY resident selling an investment property located in CA. --Federal capital gains will be assessed at 15% of the amount over straight-line depreciation. --Section 1250 depreciation recapture will be assessed at 25% of the straight-line deprecation taken. --The 3.8% Medicare surtax will be assessed on the capital gain since their MAGI is above $200K --California will tax the capital gain on sale at 13.3%. (The current capital gains tax rate for non-residents is 13.3%). Investors in this situation could also consider a 1031 exchange into a replacement property to defer the income tax implications to a future year.

This is how you can save on capital gain taxes after an exit! Securing an exit for your startup is a huge milestone but it comes with its own set of financial considerations, This tax burden can be overwhelming, but there’s good news for founders in India!  If you held shares in your company for 2+ years, the Indian ITA provides a way to potentially reduce your tax liability by reinvesting your gains into residential real estate. Section 54F allows complete exemption from capital gains tax if you meet these conditions:  → The capital gains must be reinvested in a new residential property in India. You can purchase this property up to 1 year before or 2 years after the share sale. If constructing a property, you have 3 years from the sale date to complete construction.  → You must not own more than one residential property (excluding the one you plan to purchase).  → The exemption applies only if the entire sale proceeds are invested and is capped at ₹10 crore.  For example, if you sell your company for ₹15 crore (with a zero-cost acquisition) and purchase a property worth ₹12 crore, the exemption will apply to ₹10 crore. You’ll still pay capital gains tax on the remaining ₹5 crore.  But this purchase must be for self-occupation or for a close relative. Any violation, such as selling the property within 3 years, could lead to withdrawal of the tax benefit.  If you’re a startup founder in India, how are you planning to reinvest your gains post-exit? #taxes #startups

Potential OZ investors wonder if it is too late to take advantage of the current Opportunity Zone program (OZ 1.0) or wait to see if Opportunity Zone 2.0 (OZ 2.0) will pass into law and invest under that regime.   Blake E. Christian, CPA/ MBT and his team at HCVT, leaders in the OZ CPA/consulting space, identified even more reasons for prompt OZ investment than I’ve been passing on to my clients. In summary they are: 𝐒𝐭𝐚𝐫𝐭 𝐭𝐡𝐞 𝐓𝐞𝐧 𝐘𝐞𝐚𝐫 𝐂𝐥𝐨𝐜𝐤 The 10-year clock starts when qualified capital gains are placed in a qualified opportunity fund (QOF). There is no required holding period for investments thereunder. This means, for example, that if it takes three years to acquire a qualifying investment (which can be available under the OZ rules) they it need be held only seven years.   𝐁𝐞 𝐏𝐨𝐬𝐢𝐭𝐢𝐨𝐧𝐞𝐝 𝐟𝐨𝐫 𝐃𝐞𝐟𝐟𝐞𝐫𝐚𝐥 The current deferral period for recognizing and paying tax on the original capital gain is deferred to December 31, 2026 (with the tax payable April 15, 2027) this remains effectively an interest-free loan – very valuable for short or long-term capital gains of any significant size. Further it seems very likely that OZ 2.0 will extend this deferral period.   𝐓𝐚𝐤𝐞 𝐂𝐨𝐧𝐭𝐫𝐨𝐥 𝐚𝐧𝐝 𝐈𝐧𝐯𝐞𝐬𝐭 𝐒𝐨𝐨𝐧𝐞𝐫 A captive QOF, one that is wholly owned and managed by the taxpayer (or a family office), offers full control over the investment process, timeline, and investment selection. Rather than waiting for OZ 2.0, investors can promptly deploy capital into investments that can begin to appreciate, which can result in a stronger compounding effect. Delaying investment until OZ 2.0 is legislated risks missing out on current opportunities and sooner deployment of capital.   𝐂𝐞𝐫𝐭𝐚𝐢𝐧𝐭𝐲 𝐨𝐟 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐢𝐧 𝐭𝐡𝐞 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐎𝐙 𝐓𝐫𝐚𝐜𝐭𝐬 The currently designated OZ tracts are known and lend themselves to effective investment analysis. It is unknown the tracts that may be applicable to OZ 2.0 but it is certain that there will be significant differences than currently exist.   𝐀𝐛𝐢𝐥𝐢𝐭𝐲 𝐭𝐨 𝐃𝐞𝐟𝐞𝐫 𝐀𝐝𝐝𝐢𝐭𝐢𝐨𝐧𝐚𝐥 𝐅𝐮𝐭𝐮𝐫𝐞 𝐂𝐚𝐩𝐢𝐭𝐚𝐥 𝐆𝐚𝐢𝐧𝐬 Many taxpayers generate new capital gains throughout the year. Once the taxpayer has established iys captive QOF there is significant flexibility to reinvest these expected and unexpected capital gains. 𝐑𝐞-𝐓𝐫𝐢𝐠𝐠𝐞𝐫 𝐭𝐡𝐞 𝐆𝐚𝐢𝐧 𝐈𝐟 𝐍𝐞𝐰 𝐎𝐙 𝐑𝐮𝐥𝐞𝐬 𝐇𝐚𝐯𝐞 𝐀𝐝𝐯𝐚𝐧𝐭𝐚𝐠𝐞𝐬 If OZ 2.0 is more attractive than OZ 1.0 taxpayers may have the ability to “re-trigger” their original capital gain through an “inclusion event”, a distribution or a “decertification” of the QOF and reinvest into a newly structured QOF under OZ 2.0. But failing to capitalize a QOF now under OZ 1.0 will eliminate the chance to take advantage of OZ 2.0. Read Blake's white paper for more details.