Taxes and Selling a Business
People hire financial advisors for their wide breadth of knowledge. Very often, advisors can find obscure provisions that could be perfect for you. The collective expertise on my team, for example, helped save a business owner $400,000 in taxes and still guarantee a lifetime income.
I recently met with a prospective client who wanted to sell her truck tire distribution business. Her three main concerns were avoiding tax on the sale, preserving a lifetime stream of income and making sure her employees retain their jobs going forward.
With the help of our expert team, including a wealth manager, accountant, business attorney, business appraisal expert and a business broker, we concluded that the owner could meet her three objectives using two entities: a Section 1031 exchange transaction and a charitable remainder trust.
Section 1031 allows business owners to defer capital gains taxes if the seller uses the proceeds to reinvest and buy another similar property. For example, if you buy a restaurant for $1 million and sell it for $1.2 million, you usually pay for capital gains on the $200,000 profit. But if you turn around right away and purchase a $1.2 million supermarket, you don’t have to pay capital gains.
In a 1031 exchange, the seller must identify and purchase a property within a specified time after selling the first property. As long as you the seller use a qualified intermediary and don’t cash out, you incur no capital gains tax. You need to buy a qualifying property to meet the exchange requirement.
The business owner that I helped didn’t need a lump sum of cash from the sale, so this was perfect for her. We recommended that she swap the building housing her tire distributorship for an apartment building to provide a steady stream of income from tenant rents.
But her tire business still had assets aside from the real estate: inventory, equipment and receivables. So we set up a second entity to shelter that, the charitable remainder trust (CRT). Transferring those assets to a CRT is tax-free and removes it from the owner’s estate.
If you set up the trust properly, you also get a current tax deduction. With a CRT, you get a tax deduction for what amounts to a donation, and you get income from it for the rest of your life. The income amount is based on your age, the amount of the gift (value of the sell), the cost basis and your income tax bracket. When you die, in most cases, the charity gets the asset.
So the owner actually has two income streams: one from the 1031 apartment building and one from the CRT annuity.
One of the issues many business owners faced in the past was choosing the charity. That decision used to be irrevocable. The good news is you can now name the charity and change later if you wish.
The business broker on the team helped achieve the client’s third goal, guaranteeing that her employees are kept on after the sale. The broker found a supplier that wanted to expand their business by becoming a distributor. This was the perfect fit. The supplier promoted the operations manager to run the distributorship and retained all of the employees.
These strategies save the owner over $400,000 in taxes and provide her a monthly income of over $11,000 from her rental property and the CRT annuity. Along with her personal assets, she is set for life.
Disclosure: While these strategies were useful for this client, they may not be suitable for all business owners.
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Scott Thompson is the co-founder of Thompson Wealth Advisors (TWA), a Registered Investment Advisory firm with offices in Statesville and Mooresville, N.C. TWA specializes in helping business owners maximize the value of their business and preserve their personal wealth. Scott holds Series 7, 24, 63 and 65 licenses and is a Certified Specialist in Retirement Planning. Laura Thompson (co-founder) is a Certified Public Accountant and Certified Specialist in Estate Planning.
Securities offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Business Exit Planning Services are only offered through Thompson Wealth Advisors, RIA.
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