The stock market has been red-hot, at least for certain industries and sectors, and some savvy buyers have used new highs as opportunities to take profits. Although their long-term capital gains are taxed at a relatively low rate of 20%, our clients often ask us about ways to shelter such profits from taxes.
Many investors know that gains realized on the sale of real estate can be postponed by exchanging one property for another. Strategies have emerged to allow such tax-deferred exchanges to do their magic even where the seller and buyer aren't looking to deed their real estate to each other.
And people who own life insurance may know that they can exchange their policies for other policies without any tax cost. Some policyholders have found this opportunity particularly attractive as they move the cash value of their policies from older contracts, whose growth is tied to modest interest rate-sensitive yields, to those whose performance is linked to the stock market.
But most investors would be surprised to learn that an analogous tactic applies to capital gains realized on the sale of publicly traded securities.
The tax trick creates a tax deferral on stock profits reinvested in Small Business Investment Companies (SBICs), a specially treated venture capitalist which provides equity or loans to small businesses. SBICs are backed by the Small Business Administration and, over the years, have become a major source of small-company funding.
Let's suppose you've made a killing on Internets 'R Us (no, it's not a real company, so far as we know). And you're not eager to share your good fortune with the folks in Washington.
All you'll need to do is invest some or all of your gain (for an individual, up to $50,000 each year, with a lifetime maximum of $500,000) in an SBIC within 60 days after it is realized. Attach a statement to Schedule D of your tax return, describing how your tax basis and deferral were computed, and you will have postponed your tax until your SBIC investment is sold -- unless you roll over any gain you realize on its sale into another so-called "qualified small business stock." But you may decide to pay the piper instead; gains from SBIC investments are taxed at a bargain rate of only 14% if they're held for more than five years.
Not surprisingly, there are some tax rules governing how all this works. And SBIC investing is not without risk -- a risk the Government will share with you by allowing investors to deduct any losses immediately and in full. The best SBICs are careful in underwriting their loans and equity placements and many of them have attractive track records. Fed Ex, Apple Computer and AOL, among others, are companies which were launched with SBIC money.
To learn more about SBICs and their potential to defer taxes and grow wealth, visit SBA's website at www.sba.gov or give us a call.
Marc Lane is a business and tax attorney, a Master Registered Financial Planner, a Registered Financial Consultant, and a Certified Investment Specialist. Marc is the author of 30 books on business organization, taxation, and personal finance. His newest book, "Advising Entrepreneurs: Dynamic Strategies for Financial Growth" draws from his experience working with those who have successfully built their businesses. Marc is an Adjunct Professor of Law at Northwestern University and an Adjunct Professor of Business at the University of Illinois. His practice areas include Individual Taxation, Corporate Tax Planning, Business Tax Planning, Estate Planning, Investments, Retirement Planning,Elder Law, International Trade, Business Law, and Wills, Trusts and Estates. Additional articles, case studies, and a free email newsletter are available at www.marcjlane.com.
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