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Tax Planning for Unrealized Gains

Tax planning for unrealized gains helps you keep more of your hard-earned gains by reducing your applicable taxes. Unfortunately, most people are unaware of how impactful it could be and that it could boost their investment returns by 40% or more! The goal of tax planning is to make sure there is tax efficient and it should be essential for anyone’s financial plans, but what exactly is it?

Why is Tax Planning Important?

Tax planning is the process of analyzing and preparing a financial plan or a situation from a tax perspective that helps you to legally minimize how much you pay in taxes to help you keep more of your earned money, both for your use over time and to build your wealth for the long term.

We know there’s nothing simple about taxes, so Valur is here to help by taking the sophisticated tax planning and asset protection tools of the ultra-rich and making them seamless and accessible to everyone.

If you’re still holding your assets and you’ve got a big gain coming, (or even if you have taken gains off the table recently or received a large amount of income from selling an asset, please see our Realized Income guide if you would like to read more about it) – Valur can help you understand, choose and set up the right tax planning structure.

In this guide, we’ll focus on the characteristics of three different tax planning structures commonly used for unrealized gains, and we’ll also use an example to help you visualize the benefits and the tradeoffs of each one.

Tax Planning for Unrealized Gains

Unrealized gains are the hypothetical gain you would realize above your purchase price if you sell any financial instrument at the current market price. In other words, these gains are the potential profit that you would gain from selling any investment.

Realized gains, instead, are the actual gains that take part as a result of a sale of any financial instrument.

Tax strategies for unrealized gains

We are going to walk through a few tax planning structures for unrealized gains:

  • Charitable Remainder Trusts
  • Exchange Funds
  • Opportunity Zones

Charitable Remainder Trusts (CRTs or CRUTs)

CRUTs are tax-exempt accounts for appreciated assets you have not sold yet. They are like a more flexible IRA, but they have no contribution limit and they allow you to use your money today instead of having to wait until you are 59.5.

Their key benefits are:

  • Tax deferral: Most gains inside the trust are not taxed, enabling you to avoid paying taxes upfront when you sell your crypto assets so you can keep reinvesting those tax dollars until you receive a distribution from the trust, allowing more tax free growth and compounding.
  • Lower tax rates: by realizing your gains over a number of years, you can effectively smooth out your income and avoid spiking your tax rates in any individual year. In exchange for donating some of the money in the trust to a charity of your choice at the end, you also get an immediate tax deduction from the government.
  • You can use your money to make the same investments you would if you were investing out of a taxable account.

Timeline and distribution strategy

There are another two key decisions to make when establishing a CRUT:

  • Length. This determines how distributions to beneficiaries will be made and can be for either the remainder of your a person(s) lifetime or for a period between 2 and 20 years.
  • Distributions. There are multiple distribution strategies, and your choice affects the consistency of your distributions and the return you get from the structure. Please visit our post to explore more on the topic.

One important trade off of these structures is they have a limitation if you would like to leave your money to another beneficiary in case something happens to you. However, it is also good to know there are strategies that can help you work around to make sure you don’t lose the value of your trust.

Exchange funds

Exchange funds are similar to a mutual fund: they are a type of investment vehicle consisting of a portfolio of stocks, bonds or other securities, but instead of contributing cash, you contribute stock.

Their key benefits are:

  • Transactions are not immediately taxed: U.S. tax law allows you to swap highly appreciated stock for shares of ownership in these entities without triggering capital-gains tax.
  • Reduction of portfolio risk: by aggregating the concentrated stock positions, they allow you to substitute or replace your own concentrated stock position with a diversified basket of stocks of the same value.

The main downsides of Exchange Funds include the following:

  • Annual management fees typically range from 1.00% to 2.00%.
  • You must hold fund shares for at least seven years and at the end of the period you have the option to receive a basket of stocks, none of which is your original stock.
  • Funds minimums often run from $500k to $1M and accepted assets are usually limited to public stocks with enough liquidity

If you’re interested in learning more about Exchange Funds, please visit our blog post on this topic here.

Opportunity Zones

Opportunity Zones are an economic development tool that allows you to invest in distressed areas in the United States through tax deferrals.

Investments in Opportunity Zones are eligible for preferential tax treatment if they are made through a Qualified Opportunity Fund (QOF), which is an official designation for investment vehicles that commit to investing 90% or more of its assets in Qualified Opportunity Zones.

Some of the advantages include:

  • Capital gains rolled into a QOF may be deferred until the investment is sold or exchanged, or the end of 2026, whichever comes earlier.
  • You can save even more through an adjustment in the cost basis of your QOF investment. If you hold the investment for at least 10 years, you can avoid taxes entirely on the sale of the Opportunity Zone investment.

The main downsides of Opportunity Zones include:

  • Higher fees vs more traditional investments
  • A long period of illiquidity: money has to stay in a QOF for at least five years from the fund close to realize the tax reduction benefits and ten years from the fund close (not when your investment is made) to realize the basis adjustment benefit.
  • Your investments are highly concentrated in real estate and a limited number of projects.

If interested in reading more, please check our blog post for a detailed explanation of Opportunity zones.

Comparing CRUTs, Exchange Funds and Opportunity Zones

As you might guess, each structure has its own set of positive and negative trade-offs. Choosing which one to use is a personal decision that depends on your circumstances, financial goals and broader priorities.

Below, we’ll compare each across several useful metrics, including, most importantly, the bottom line: how much you’ll earn using each.

Comparing the Return on Investment (ROI) of each structure

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.

Through the example, we will 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).

Chris is 35 years old, based in California, with a $1m appreciated asset at a $0 cost basis. He expects 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 would be as follows:

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

You can also find more detailed information about the three structures and their trade-offs in this article.

In conclusion, Charitable Remainder Trusts, Exchange Funds and Opportunity Zones 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.

There’s no “one size fits all” solution, and the right choice will depend on your personal preferences and tax position.

About Valur

Valur has a singular goal: help our customers access tax planning structures that are otherwise inaccessible to them. From picking the best strategy to organizing your distributions and other important financial events, we’ll be with you the whole way.

We have built a system to streamline the tax planning tools of the ultra-rich to make them seamless, affordable and accessible to everyone. We’re the only providers of crypto-focused, technology-first tax planning tools.

What we offer:

  • Simplicity and speed: comprehensive trust structuring to maximize tax protection and completed, vetted legal documents to establish the trust.
  • Trust administrative management (federal and state filings, trust accounting and distribution management)

If you would like to learn more, check out your potential tax savings with our online calculator or schedule a time to chat with us!