Tax Deferral Strategy: Comparing the Big Three

Each structure has its own set of positive and negative trade-offs for a tax deferral strategy. But on an ROI basis, Charitable Remainder Trusts have the highest ROI because of their lower cost structure and ability to defer taxes for a longer time horizon

Record capital gains from startups and the public markets. New, fast-growing asset classes like crypto. Ever-increasing (and more complicated) state and federal taxes. For many reasons, interest in tax planning has skyrocketed over the past few years. At the same time, and for many of the same reasons, tax planning strategies — some legitimate, some gimmicks — have proliferated.

When we began writing on these subjects, we set out to demystify things for those who were looking at tax planning for the first time. To that end, over these past months, we’ve written about some of the most popular tax planning structures, including Charitable Remainder Trusts, Charitable Lead Annuity Trusts, Opportunity Zones, and Exchange Funds. Today, we thought it’d be helpful to share a comparison of these tools, drawing on all of the thoughtful questions we’ve received from you all.

First, a quick summary of the most popular strategies available.

Charitable Remainder Trusts (CRUTs) Overview

A Charitable Remainder Trust is a tax exempt trust that allows you to sell appreciated assets and defer the associated income taxes until you receive a distribution, thereby growing your money faster with the magic of compounding — kind of like a more flexible version of an IRA. A charitable remainder trust distributes income to the trust beneficiaries (usually you and/or your family) for a specified period — up to 20 years or the length of your and others lifetime — and, when that period is over, donates the remainder — everything that hasn’t been distributed yet — to your chosen charity.

Opportunity Zone Overview

Opportunity Zones are a way to defer capital gains taxes on capital gains you’ve recently realized. Investors who have eligible realized capital gains (from the sale of stocks, real estate, business interests, or other investments) can roll those gains into a Qualified Opportunity Fund (”QOF”). If they do so within 180 days of realizing the gain, two forms of tax incentive are available. First, capital gains rolled into a QOF may be deferred until the investment is sold or exchanged, or the end of 2026, whichever comes earlier. Second, the investor can save even more through an adjustment in cost basis of their investment. If the investor holds the investment for at least 10 years, he or she can avoid taxes entirely on the sale of the Opportunity Zone investment.

Exchange Fund Overview

An exchange fund is similar to a mutual fund but, instead of contributing cash, the fund owners contribute stock. Because of exchange funds’ limited partnership structure, U.S. tax law allows investors to swap highly appreciated stock for shares of ownership in these entities without triggering capital-gains tax. By aggregating the concentrated stock positions of many investors, an exchange fund allows you to substitute or replace your own concentrated stock position with a diversified basket of stocks of the same value. Because the transaction is not immediately taxed, you can diversify without paying taxes up front.

Comparing the Return on Investment (ROI) for Tax Planning Strategies

We understand that this can be a lot to digest, and while the qualitative trade-offs above are important, it’ll be helpful to walk through an example to see the ROI of each structure.

Let’s start with our goal and a few baseline assumptions.

Goal: Evaluate each of these tax planning structures based on post-tax return on investment after year 10. (Any payouts that might happen after year 10 are discounted by their growth rate, to calculate the net present value in year 10.)

Baseline Assumptions: The individual is 35 years old, based in California, with a $1m appreciated asset at a $0 cost basis. They expect a 35% tax rate (long term capital gains) and for the stock market to grow 10% annually, while an opportunity zone investment would appreciate 9% annually (net of fees). This also assumes a base level of expenses for each strategy.

The order of returns by strategy is as follows:

  1. Charitable Remainder Trust (NIMCRUT): $2,152,019 – additional 57% return
  2. Opportunity Zone: $1,828,845 – additional 33% return
  3. Exchange / Swap Fund: $1,594,559 – additional 16% return
  4. No Tax Planning: $1,373,934 – 0% return

Next Steps

Charitable Remainder Trusts, Opportunity Zones, and Exchange Funds are all viable options for tax planning, with each offering its own merits.

  • CRUTs tend to be the highest ROI and the most flexible
  • OZs allow you to reduce your taxes after the fact and in future tax years
  • Exchange Funds give individuals with concentrated public stock positions the opportunity to diversify

Keep reading our post on how to defer your taxes with a CRT to learn more on tax deferral strategies. Try our CRUT calculator to evaluate the potential return on investment given your situation. And if you have any questions, reach out to us!

About Valur

We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder) and others. Valur makes it simple and seamless for our customers to utilize the tax advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we make take care of it and make it easy.