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CYA Trust Strategy to Defer Capital Gains
For the investor who does not want to continue holding investment property or remain in the same business or liquidate crypto currency or selling an appreciated million dollar home, a CYA Trust Strategy should be considered. According to Section 453 of the Internal Revenue Code, the CYA Trust Strategy provides investors a solution whereby they can defer capital gains upon sale of their assets and redirect the sale proceeds into cash or whichever types of investments suit their needs, income requirements, and objectives.
What is a CYA Trust Strategy?
How Does a CYA Trust Strategy Work?
The process begins when a property or business owner transfers his asset to a trust managed by a third-party company on his behalf. The third-party company acts as trustee over the asset, and the owner is the beneficiary of the trust that holds the asset. The trust will sell the asset for the owner and manage and distribute the sales proceeds of the trust according to an agreed-upon installment contract that the owner sets up ahead of time with the trust. The sales proceeds can be held in cash, reinvested, and distributed according to the direction of the owner's installment contract. There are zero taxes to the trust on the sale, since the trust purchases the property from the owner for the same price for which it is sold.
The tax code does not require payment of any of the capital gains taxes until an investor starts receiving installment payments that include principal. The owner then is able to control if, when, and how there will be capital gains tax exposure over the installment contract period by adjusting the installment contract. The installment contract between the owner and the trust company provides flexible options on when and how payments can be
made. Initially, the owner may have other income and may not need the installment payments right away, which would defer income and capital gains taxes.
Basic Guidelines for a CYA Trust Strategy to Work
Trust Structure: In order for a CYA Trust Strategy to qualify for capital gains tax deferral, it must be considered a bona fide, third- party trust with a legitimate, third-party trustee.
Independent Trustee: The CYA Trust Strategy must employ a trustee that is truly independent from the owner/beneficiary of the trust. If there is not real trustee independence from the owner, the IRS considers this to be a sham trust, set up for the sole purpose of creating layers of legal documents to avoid taxation. The independent trustee is responsible for managing the trust according to the laws that govern trusts, according to the installment contract, and according to the investor's risk tolerance and investment objectives.
Asset Transfer: In order for the CYA Trust Strategy to shield the owner from capital gains taxes, the owner must not take constructive receipt of any sales proceeds from the disposition of an asset. The trust created on behalf of the investor must take legal title to sale proceeds directly from the disposition of an asset or from a third-party qualified intermediary that is holding the sale proceeds on behalf of the investor in order to qualify for capital gains tax deferral.
Asset Ownership: Asset ownership must be legitimately transferred to the trust prior to a sale for the sale proceeds to be sheltered from capital gains tax. If the owner did not transfer practical ownership over to the trust and still retains all of the benefits of direct ownership, the IRS disallows the owner from enjoying the tax-advantaged benefits afforded by the trust's ownership. In other words, the property must be legitimately transferred to the trust or it will be taxed as if it were not.
Assets Must Remain in Estate: The owner cannot use the trust to transfer any economic interest to a third party without due compensation. The IRS does not allow this type of transaction because it allows people to pass assets out of their estate without bearing capital gains, gift, income, or estate taxes.
Trust Restrictions and Law: The owner/beneficiary of the trust must be subject to the restrictions imposed by a trust agreement or the law as it applies to trusts and transferred
assets. If the owner enjoys unrestricted use and control over the assets of the trust without fiduciary limitations, the IRS considers this to be a sham trust that does not qualify for capital gains tax deferral.
10% Seed: The grantor makes an initial “seed” gift of at least 10 percent of the total transfer value to the trust so that the trust has sufficient capital to make its payments to the grantor. Typically, the transaction is structured so that a completed gift occurs for gift tax purposes, with no resulting income tax consequences.
Conclusions
- The CYA Trust Strategy helps a client reinvest the 20%-40% that would normally be paid in capital gains tax.
- ·Works as an alternative to a 1031 tax exchange and gives the investor control of cash
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