The Tax Cuts and Jobs Act is certainly not without its issues, but that does not mean it is also without opportunity, Erin Avnet said.
“With the Tax Cuts and Jobs Act, (a couple of) things happened in regard to what individual taxpayers are able to deduct on their tax return,” said Avnet, partner at Citrin Cooperman, an international assurance, tax and advisory firm with New Jersey offices in Livingston. “One, the standard deduction increased; two, there were new limits placed on the deductible state and local income taxes; and three, there were new limits placed on mortgage interest deductions, which makes it less likely for taxpayers to itemize now, especially New Jerseyans and people living in other high-income tax states.”
When the law changed, a widely publicized concern was whether people would be less likely to be so charitably inclined if they were unable to get an itemized deduction due to their not exceeding the standard deduction.
“However, one strategy that allows an individual to get a larger tax benefit than what the standard deduction is now set at, although it’s increased, is to ‘bunch’ charitable donations in a given year, while limiting donations to charity in other years,” Avnet said. “If you know what you are going to donate annually, or you typically donate a certain percentage of your income, instead of doing that repeatedly over three years, combine those multiple years of what you typically would have donated into a single tax year.”
In such a “bunch” year, Avnet added, the taxpayer would get the combination of the charitable contributions with the other itemized deductions that are allowable, which is the $10,000 limit on the state and local taxes, plus the mortgage interest deduction.
“That increases the likelihood of exceeding the standard deduction in that given year, which allows for greater tax savings,” she said.
TCJA also brought with it an additional investment vehicle — and an opportunity to further reduce taxes.
“As we near year-end tax planning for all of our clients and we are doing the typical advising on what we think they should pay in for their fourth-quarter estimated tax payments, this happens a lot: We get your year-to-date investment income and realized gain-losses through your brokers. If you had a good year, now, all of a sudden, you have $1 million in long-term capital gains, when maybe you didn’t have much in the way of gains prior to,” Avnet said. “In the past, what we would have asked our clients is, can we harvest any losses before year-end? Do you have any unrealized losses in your investment portfolio that we can sell off to reduce or mitigate the long-term gains and the gains tax on that?
“But now, the Qualified Opportunity Funds provide another option in which to reduce taxes.”
Qualified Opportunity Funds are an investment vehicle organized as a corporation or a partnership for the purpose of investing in qualified Opportunity Zone property.
“One of my clients took advantage of this in 2018 because she realized significant capital gains through her brokerage accounts,” Avnet said. “We were very involved in the process of her finding and selecting the fund with her financial adviser.”
Taxpayers can take capital gains from the sale of any asset as long as they reinvest it into a Qualified Opportunity Fund within 180 days of the sale.
“The benefit from that is the tax is deferred until the sale of that new investment, or year-end 2026, whichever is earlier,” Avnet said. “That is why it is important for your trusted Certified Public Accountant to work alongside your financial advisers throughout the year, so we don’t find out about this until it’s too late to use this as an opportunity to reduce taxes.”
Avnet said there are also some guidelines to stick to in order for it to work.
“You will get a step-up in basis for capital gains reinvested in a Qualified Opportunity Fund,” she said. “The basis is increased by 10% if the investment in the fund is held by the taxpayer for at least five years and by an additional 5% if held for at least seven years, thereby excluding up to 15% of the original gain from taxation.
“You can have a permanent exclusion on investments held for 10 years, where you will pay no capital gains tax on the post-acquisition gains in that fund, meaning, from the date you invest, you basically roll over your capital gains into this fund and any appreciation from the date you invest, there is no capital gains tax on that.”
This should be therefore considered a long-term investment, Avnet added.
“You have to know your clients, because this has to make sense for them, their age, their total portfolio, their appetite for risk, because Opportunity Zones are areas which are economically distressed that are trying to incentivize people to invest in them,” she said. “It’s not for everyone, but it’s definitely a great tool to defer taxes.”
Reach Erin Avnet, partner at Citrin Cooperman, at: citrincooperman.com/professionals/erin-avnet.