ELITE ADVISOR BEST PRACTICES
Selling Collectible Cars Without Driving off the Tax Cliff
How do your clients sell a rare $7.5 million Ferrari with a low cost basis in ten minutes without pulling the tax equivalent of a Thelma and Louise? Find out here.
By Randy Fox
- Collector cars and other collectibles are considered tangible personal property and incur capital gains tax when sold for a profit.
- A Flip-CRUT is a special type of charitable trust that allows non-income-producing assets to be placed in trust until a triggering event “flips” the trust to a Standard Charitable Remainder Unitrust (SCRUT).
- Flip-CRUTs are exempt from income tax, and therefore the sale leaves the entire $7.5 million available for reinvestment.
Portions of this article published in cooperation with the Planned Giving Design Center Network.
Think back to this time a year ago. The fiscal cliff “crisis” that dominated the financial news ended up being resolved with very little impact on most taxpayers. There were no real surprises in the new law except, perhaps, the continuation of the $5 million estate exemption.
That’s generally good news for collectors, especially high-end car collectors. Not only do they frequently occupy the high-net-worth demographic, but they are uniquely passionate about and driven by their hobby. At the recent collector car auctions, a rare 1962 Ferrari 250 GT Spyder sold for $7.5 million in less than ten minutes of bidding. In fact, at this particular auction site, 12 cars sold for more than $1 million each, while the auction average was over $336,000 per vehicle. There were serious financial commitments from all sides of the transactions, indeed.
However, when you take away the passion of the frenzied bidding, the new acquirer’s joy and the seller’s relief, there is a personal economic impact that must be considered. Collector cars and other collectibles are considered tangible personal property, and when they are sold for a profit, the seller owes capital gains tax. The maximum tax bracket at the federal level is 28 percent, while state tax varies depending on the residency of the seller. Because sellers are often so caught up in the fun part of collecting, they often don’t think about various planning methods they can use prior to the sale in order to reduce their taxes.
As an example, let's take the $7.5 million Ferrari. The seller purchased the car for $2.3 million and invested another $600,000 in a complete ground-up restoration. That means that before selling costs, his tax basis was $2.9 million ($2.3 million + $600,000), and thus his capital gain was $4.6 million. Following the sale, the seller owes a nice 28 percent tax check in the amount of $1.288 million to the federal government. He nets around $3.3 million, and life goes on. However, let’s look at an alternative approach that might make this transaction even more favorable for the seller. Prior to the auction, let’s say our 63-year-old seller and his 61-year-old wife transfer their Ferrari to a Flip Charitable Remainder Unitrust (Flip-CRUT). A Flip-CRUT is a special type of charitable trust that allows non-income producing assets to be placed in trust and then, following a “triggering event” defined in the trust document (in this case, the car is sold), the trust “flips” to a Standard Charitable Remainder Unitrust (SCRUT) and begins distributing income normally to the husband and wife who established it.
What are the consequences of this transaction for the seller? First, because the balance of the trust will pass to charity when the second of the sellers dies, there is a charitable income tax deduction available. The deduction is based on the present value of their future jpgt and is calculated by a formula that takes into consideration the fair market value of the car, the amount of income to be paid from the trust, the number and ages of the income recipients, and current interest rates. In this case, because this is tangible personal property, special rules require the deduction to be calculated based on the tax basis of the contributed property, not on the full fair market value. In this case, we know the basis was $2.9 million.
This technique produces a charitable income tax deduction of a little more than $683,000. Even in the 35 percent income tax bracket, this will save the seller almost $240,000 in income taxes. And as with other charitable deductions, our Ferrari sellers have this year and the next five years to utilize the deduction on their income tax return.
Next, there is NO capital gains tax due on the sale. Flip-CRUTs are exempt from income tax, and therefore the sale leaves the entire $7.5 million available for reinvestment. Only the income distributed from the trust is subject to income tax. Ultimately, this will produce an income stream for our selling couple that will continue for their lifetimes. Income from a 6 percent payout trust, which was utilized for this example, begins at $450,000 per year.
If all goes perfectly, the Ferrari sellers will receive over $12 million in income from the trust over their anticipated lifetimes of a little over 26 years, based on an assumed trust earnings rate of 7 percent. They’ll save over $1.5 million in income tax through the avoidance of the capital gains tax and their charitable deduction, as well as leave a charitable jpgt of close to $10 million to the charities they choose. They will also remove the value of the Ferrari or its sales proceeds from their estates. And while they have done that, they have also removed it from their children’s inheritance. That issue can be resolved, if they so choose, with the purchase of life insurance outside the estate to replace the value of their charitable jpgt for their children.
NOTE: A simple sale versus CRUT analysis illustrates that available capital for investment is 20.4 percent higher with the CRUT and income is 17.2 percent higher compared with an outright sale.
While collectors pursue their passion for assets, advisors must position themselves in a way that allows the collectors to be more informed about the various choices that are available for the ownership and effective disposition of their collectible assets. This may mean millions of dollars to the collector over the course of a collecting lifetime.